Opinion ID: 1944530
Heading Depth: 1
Heading Rank: 1

Heading: Adjustments Based on Gas Purchases from Subsidiary

Text: In arriving at the figures it used to make the final calculation of CLECO's actual rate of return, the Commission adjusted CLECO's rate base and operating income to attribute to it more than $7,000,000 in revenues earned by Louisiana Intrastate Gas Corporation (LIG). Although the Commission did not seek to exercise jurisdiction over LIG in this case, the agency contends the action was justified because LIG is a wholly owned subsidiary which realized a 45% rate of return on its average book equity in the test year; and its income was derived in substantial part from sales of gas to CLECO. The major issue in this case is whether there is warrant in the record and a rational basis in law for the adjustments, despite the absence of any finding by the Commission that CLECO manipulated its subsidiary or that the price paid LIG for gas was unreasonable. The facts are not in dispute. Louisiana Intrastate Gas Corporation (LIG), a separate corporate entity wholly owned by CLECO, was incorporated in 1955. Its officers, headquarters and employees are separate and distinct from those of CLECO. Although LIG supplied nearly all of CLECO's fuel in the test year, 66% of LIG's sales of gas and 78% of its pipeline throughput were to non-affiliated industrial and municipal customers. In fact, LIG owns and operates the most extensive intrastate gas pipeline system in Louisiana, serving approximately 62 towns and communities and 51 non-affiliated industrial customers. Although the Commission has the power to disallow as an operating expense amounts paid by the utility which are unjust or unreasonable and designed for the purpose of concealing, abstracting or dissipating the net earnings of the public utility, La.R.S. 45:1176, the Commission in the instant case did not determine that the prices paid by CLECO to its subsidiary for gas were unjust or unreasonable. Indeed, the evidence of record indicates that the prices were fair, reasonable and comparable to the prices which LIG charges its other non-affiliated customers in arm's length transactions. Of LIG's 52 industrial customers CLECO's price for boiler fuel ranked 40th when prices were arranged in descending order. Moreover, the price charged CLECO for boiler fuel was identical to the price charged two of LIG's non-affiliated electric utility customers. The Commission contends that it has not attempted to regulate the price of gas sold by LIG in the present case. In its order the Commission declared that it is obligated to insure that the earnings on investment in LIG used to produce fuel for CLECO are not improperly excessive, p. 3, and that it must insure that these fuel costs generate no more than a fair profit. p. 4. In furtherance of these perceived duties, the Commission concluded that [t]o insure that the rate payers of CLECO are treated fairly, the Commission will allow CLECO and LIG to earn only the fair rate of return on the investment in LIG used to produce fuel for CLECO. p. 4. To effectuate this policy the Commission made regulatory adjustments by, first, determining the ratio that LIG's sales to CLECO bear to LIG's total sales and, second, by including this percentage of CLECO's investment in LIG in CLECO's rate base; and by including the same percentage of LIG's income from gas sales in CLECO's operating income. The adjustments resulted in additions of $8,160,000 to CLECO's rate base and $4,739,000 to its operating income. CLECO contends that but for these adjustments the Commission would have been required to grant it a rate increase to provide $7,281,000 in additional annual revenue. Manipulation by a parent utility of a subsidiary for the purpose of creating excessive profits at the expense of the rate payer would provide a reason for the regulatory agency to disregard corporate entity and attribute subsidiary assets and earnings to the parent. See, City of Los Angeles v. California Public Utilities Comm'n., 94 PUR 3d 226, 7 Cal.3d 331, 102 Cal.Rptr. 313, 497 P.2d 785 (1972); Illinois Bell Telephone Co. v. Illinois Commerce Comm'n., 3 PUR 4th 36, 55 Ill.2d 461, 303 N.E.2d 364 (1973); Washington Water Power Co. v. Washington Utilities & Transportation Comm'n., ___ PUR 4th ___, No. 59791 (Wash. Superior Ct., Nov. 2, 1978). In the present case, however, there is no evidence that the subsidiary corporation has been used as a mere instrumentality or adjunct for such a purpose. LIG was organized as a gas pipeline company in 1955 for the purpose of assuring CLECO an adequate supply of natural gas. However, because of CLECO's limited fuel requirements, LIG was required to develop additional customers who have no affiliation with CLECO in order to sustain an operation of sufficient size to have competitive gas purchasing power. As noted, LIG's separate management has developed Louisiana's most extensive intrastate pipeline and relies on CLECO as a market for only 34% of its gas sales and 22% of its pipeline throughput. The Commission does not question the wisdom or legitimate motives of CLECO in organizing a separate corporation for the purpose of developing a dependable source of fuel. In short, LIG seems to have acquired a vigorous and somewhat independent corporate character, and if the subsidiary receives substantial profits for its gas, the record in this case suggests that it is probably due to the energy crisis and not by the design or manipulation of CLECO. Unreasonably high charges by a subsidiary for its products or services, even if provided for by legally enforceable contract, may afford a rational basis for adjustments by the agency in the rate making process. Clearly, as mentioned above, the Commission has the power to disallow any unreasonable or unjust operating expense paid by a parent utility in fixing rates. La.R.S. 45:1176. Before the regulatory body can make this type of adjustment, however, there must be warrant in the record of the rate case for a factual finding, or at least a reasonable inference, that the charges or expenses, are in fact unreasonable. In the instant case the Commission failed to find that the prices were unreasonable when compared with LIG's prices charged non-affiliated utilities or with prices charged by independent suppliers; and the evidence would not have supported such a finding. Notwithstanding the absence of manipulation or payment of unreasonable gas prices by CLECO, the Commission argues that its action was justified simply because LIG is a wholly owned subsidiary which profited substantially from the sale of gas to its parent and earned approximately 45% on its average book equity during the test year. CLECO contends that, although its rate of return is lower than LIG's, the Commission has erroneously overstated LIG's actual return and wrongly assumed that it exceeded LIG's fair rate of return. Moreover, CLECO contends that under the circumstances of this case the subsidiary's earnings or return should not in any way be attributed to the parent corporation. The power of a public service commission to inquire into contracts between the company furnishing the service or commodity, the rates for which are under inquiry, and its corporate affiliate has been the subject of judicial inquiry in a number of cases. Although there is general agreement that the commission has power to inquire into the reasonableness of such contracts, the courts differ widely as to the findings required before the commission may disallow an expense or make other adjustments. Several judicial opinions have favored a narrow scope of inquiry by the regulatory agency. In these cases the courts have said that a commission cannot ignore an operating expense unless there is an abuse of discretion in that regard by the corporate officers; Southwestern Bell Tel. Co. v. Public Service Commission, 262 U.S. 276, 43 S.Ct. 544, 67 L.Ed. 981 (1923); that common ownership is not of itself sufficient ground for disregarding intercorporate agreements when it appears that, although an affiliated corporation may be receiving the larger share of the profits, the regulated company is still receiving substantial benefits from the contract and probably could not have secured better terms elsewhere. United Fuel Gas Co. v. Railroad Commission of Kentucky, 278 U.S. 300, 49 S.Ct. 150, 73 L.Ed. 390 (1929); and that a commission, operating under a state statute similar to La.R.S. 45:1176, could have disallowed an excessive price paid by a utility to its subsidiary, but the evidence would not support a finding of excessiveness where a commodity was purchased at its fair market value, and under no circumstances could the commission apportion a part of the subsidiary's profits to the parent utility. Re Montana-Dakota Utilities Co., N.D., 102 N.W.2d 329, 33 PUR 3d 531 (1960). However, such a limited ambit of inquiry is incongruous with the Louisiana Commission's broad constitutional power and authority to supervise, govern, regulate and control all common carriers and public utilities. La.Const. art. 4, § 21; cf. City of Plaquemine v. Louisiana Public Service Commission, 282 So.2d 440 (La.1974). The Commission relies on a line of cases in which courts and regulatory agencies concluded that expense payments to affiliates of a regulated utility should not produce a profit in excess of its parent's fair rate of return. Illinois Bell Telephone Co. v. Illinois Commerce Comm'n., 3 PUR 4th 36, 50, 55 Ill.2d 461, 303 N.E.2d 364 (1973); City of Los Angeles v. California Public Utilities Comm'n., 94 PUR 3d 226, 236, 7 Cal.3d 331, 344, 102 Cal.Rptr. 313, 497 P.2d 785 (1972); Pacific Northwest Bell Telephone Co. v. Sabin, 8 PUR 4th 159 (Or.Ct. App.1975); Re New England Telephone & Telegraph Co., 13 PUR 4th 65 (Me.Pub.Util. Comm'n., 1976); Re New England Telephone & Telegraph Co., 10 PUR 4th 132 (R.I.Pub.Util.Comm'n., 1975); Re The New York Telephone Co., 7 PUR 4th 496 (N.Y. Pub.Serv.Comm'n., 1974); Re General Telephone Co. of Illinois, 6 PUR 4th 90 (Ill.Commerce Comm'n., 1974); Re Michigan Bell Telephone Co., 3 PUR 4th 1 (Mich.Pub.Serv. Comm'n., 1973); Re New York Telephone Co., 2 PUR 4th 1, 10-12 (N.Y.Pub.Serv. Comm'n., 1973); Re The Pacific Telephone & Telegraph Co., 95 PUR 3d 1 (Cal.Pub. Util.Comm'n., 1972). However, all of the cases cited by the Commission involve telephone companies and are clearly distinguishable. The majority of cases cited by the Commission involve the Bell System and Western Electric, a wholly owned subsidiary which manufactures and supplies telephone equipment. In these cases the rate making body pursued a policy of adjusting the prices Western Electric actually charges its Bell affiliate to reflect no greater rate of return than would be reasonable for the regulated utility. But see, Re Northwestern Bell Telephone Co., 8 PUR 4th 75 (Minn.Pub.Serv.Comm'n., 1974). To allow a higher rate of return is considered by these jurisdictions as imposing on Bell's rate payers the burden of providing to the parent company, American Telephone & Telegraph, excessive returns on sales by Western to Bell. See, Illinois Bell Telephone Co. v. Illinois Commerce Commission, 3 PUR 4th 36, 50, 55 Ill.2d 461, 303 N.E.2d 364 (1973). This policy may be justified in light of the corporate structure of American Telephone & Telegraph, but the intercorporate relationship of CLECO and LIG does not warrant such an inflexible treatment. In the telephone cases, it was recognized that Western Electric has a unique relationship in the Bell System. Excluding government business, approximately 98% of Western Electric's total sales are made to AT&T and Western Electric virtually monopolizes the market for equipment used by the Bell System. The integrated nature and unified control of this structure effectively immunizes any transaction between Western Electric and the Bell System operations from competitive market prices and renders a comparison of its prices and profits with other manufacturers inadequate. Re New England Telephone and Telegraph, 10 PUR 4th 132 (R.I.Pub.Util.Comm'n., 1975). These unique elements are not present in the CLECO-LIG relationship. LIG and CLECO carry on different types of enterprises with separate control and a minimum of integration. 66% of LIG's total sales are made to non-affiliated purchasers at prices comparable to those charged CLECO. Since LIG does not hold a monopoly on the sale of natural gas, it is possible to realistically determine just and reasonable prices for natural gas in its competitive market. CLECO introduced undisputed evidence that the prices it paid to LIG for boiler fuel were reasonable in comparison with prices charged other LIG customers. Accordingly, the telephone company cases based upon the relationship between AT&T and its totally dominated and integrated subsidiary, Western Electric, are distinguishable and not controlling in the instant proceedings. We conclude that the Commission has the power and authority to investigate and make adjustments to assure that the utility's stockholders, through the subsidiary company, do not receive a greater return than warranted upon sales made to the utility and costs passed along to the rate payer. However, in a case such as the instant proceeding, in which the subsidiary's operations are not closely integrated in those of the parent but include substantial dealings with non-affiliated customers, and in which the subsidiary encounters business risks markedly different from its parent's, the fair rate of return of the subsidiary and not that of the parent should be the touchstone for determining if the subsidiary's profits are unreasonable and for making any indicated adjustments. Of course, in a case involving a wholly owned subsidiary, the Commission's inquiry is not concluded by the fact that comparable prices are charged by the affiliate to other utilities, or by comparable rates charged by independent suppliers. The Commission's proper concern is not the level of price at which the inter-affiliate transaction is accomplished in comparison with prices in non-affiliated transactions, but instead whether there is a level of earnings by the wholly owned subsidiary at a rate higher than the subsidiary's fair rate of return. See generally, Western Distributing Co. v. Public Service Commission of Kansas, 285 U.S. 119, 52 S.Ct. 283, 76 L.Ed. 655 (1932); Mississippi River Fuel Corp. v. Federal Power Commission, 102 U.S.App.D.C. 238, 252 F.2d 619 (1957); Washington Util. and Transp. Comm'n. v. Wash. Water Power Co., 24 PUR 4th, 427, reversed, ___ PUR 4th ___, No. 59791 (Wash.Super.Ct. Nov. 2, 1978); Wichita Gas Co. v. Public Service Commission, 2 F.Supp. 792 (D.C.Kan.1933). Turning to the record of the instant case before the Public Service Commission we find that the Commission made no determination of the fair rate of return of LIG. In fact, we cannot find in the record any financial, cost and risk data which would warrant the determination that LIG's test year rate of return was excessively unreasonable. Indeed, even the finding that LIG earned approximately 45% on its average book equity during the test year was supported only by the conclusory and sketchy testimony of a single witness. The Commission's adjustments to CLECO's rate base and operating income, therefore, were neither warranted by this record nor founded upon a rational basis in law. Accordingly, we must remand the case to permit the Commission, if it desires, to inquire into the fair rate of return of LIG during the test year and to make adjustments based thereon if indicated by the additional evidence to be presented by the parties.