Court Opinion

ID: 9661717
Source: CourtListenerOpinion
Date Created: 2023-08-23 22:47:18.133046+00
Date Added: 2024-06-11T18:14:32.931492
License: Public Domain

POPE, Justice,
dissenting.
I dissent.
The Railroad Commission and the majority have reverted to the discredited rule which applies the rate of return to the original cost depreciated. That rate base is contrary to the fair value method that was approved in Railroad Commission v. Houston Natural Gas Corp., 155 Tex. 502, 289 S.W.2d 559 (1956), prior to the adoption of the Public Utilities Regulatory Act, and it violates the statutory scheme for a fair return that is spelled out in sections 39, 40, and 41 of article 1446c. This court has previously approved and the legislature has required a method by which a return is allowed upon a ratio of both original cost and current cost which are included in the rate base. Southwestern Bell Tel. v. Public Utility Commission, 571 S.W.2d 503 (Tex.1978); Railroad Commission v. Houston Natural Gas Corp., supra; Tex.Rev.Civ. Stat.Ann. art. 1446c §§ 39, 40, 41 (1979) [hereafter “PURA”].
The hearing examiner in this case made a determination of the rate of return upon original cost depreciated which it considered sufficient to attract capital and then used that figure as the controlling consideration. He then translated that return into a percentage figure of the statutory adjusted value so that the return would exactly equal the dollar return upon original cost depreciated that was already settled upon. It is that return on the original cost depreciated which was the basis — the only basis — for the Commission’s ruling, as we shall see.
The Commission made these determinations in applying its 60/40 ratio to arrive at the adjusted value rate base.
Rate Base on 60/40 Ratio
Original Cost $ 9,675,761
Less Accumulated Depreciation (4,420,339)
Net Original Cost 5,255,422
Ratio per Sec. 41 X 60%
The 60% Element $ 3,153,253
Current Cost $30,135,506
Adjustment for Age (3,267,309)
$26,868,197
Ratio per Sec. 41 X 40%
The 40% Element 10,747,279
Construction in Progress 12,284
Working Capital + 91,366
103,650
ADJUSTED VALUE IN INVESTED CAPITAL $14,004,182
The adjusted value of invested capital, which in this case is $14,004,182, is of controlling statutory significance but the Commission disregarded it. Section 41, article 1446c, states that “Utilities rates shall be based upon the adjusted value of property used and useful to the public utility in providing service . . . .” In applying a rate upon that legislative rate base, we have previously held that there is a legislative floor and a legislative ceiling to the rate base which must be honored. Section 39 of article 1446c, which permits a utility to recover its operating expenses together with a reasonable return on its invested capital, has now been settled and declared to be the minimum rate base. As explained in Southwestern Bell Telephone Company v. Public Utility Commission of Texas, supra, section 39 which sets the minimum rate base is determined by a consideration of the reasonable return on the original cost less depreciation. We ruled further in Southwestern Bell, supra, that 40(a) of article 1446c, prescribes a ceiling for the rate base of a utility, Southwestern Bell, supra at 514. That ceiling permits a return that will not be more than a fair return on the adjusted value. A point that the Commission does not recognize is that section 41 requires a rate based on adjusted value which is a fair return but under section 40(a), not more than a fair return. The fair return under the statute must be computed on the adjusted value, not the original cost depreciated.
As a matter of statutory construction, therefore, and as this court has already ruled, the dollar return to the utility must be a fair return on the adjusted value, and *301in no event shall it be less than a fair return on the original cost depreciated nor more than a fair return on the adjusted value. But it shall be a fair return on the adjusted value. PURA § 40(a).
In Southwestern Bell, supra at 516, we rejected the idea that Texas had a dual rate base, that of original cost depreciated and that of adjusted value. In that case, we approved a rate of return of 8.37% on the adjusted value of invested capital. We approved that rate of return after satisfying ourselves that the dollar return was between the minimum or floor that would be returned on the original cost depreciated [sec. 39] and yet was a fair return — and not more than a fair return — on the adjusted value [sec. 40(a)]. Our decision in Southwestern Bell correctly decided that the rate of return should be not more than a fair return on the adjusted value of a utility’s property but not less than a reasonable return on the depreciated original cost of that property. We need to apply that same rule in this case.
The records before us show that the Commission in this case has applied the wrong rule and violated sections 39, 40, and 41 of PURA. The Commission has adopted the exact computations recommended by the hearing examiner, and those figures are solely grounded upon the wrong rate base. They are computed as a rate of return on the original cost depreciated rather than on the statutory adjusted rate base. The return on the original cost depreciated is treated as the ceiling for the utility’s return, rather than the floor. The Commission ignored the adjusted value rate base until it made its decision grounded on original cost. It then converted the percent of return on original cost to the percentage rate of return on the adjusted value so that the two would be exactly the same.
We need to trace the steps of the examiner in arriving at his recommendation. The examiner made a correct statutory determination that the adjusted value was $14,004,-182. He then quit the statutory quest for a return on that value. His report states that his next step was to turn to the original cost depreciated. The examiner’s report states, “Before the specific rate of return may be calculated by any method, it is helpful in the process to arrive at a capital structure for Entex.” [Emphasis added.] The findings made by the examiner show this as his idea of the Entex capital structure:
Entex Capital Structure
(100% Original Cost Depreciated)
Cost
Required Return
Debt (Notes & Bonds) $3,558,549 6.84% . $243,258 (rounded)
Book Common Equity 1,800,523 17.6% 316,909
(rounded)
TOTAL CAPITAL $5,359,072 $560,167
At once, it is apparent that the item, “Total Capital,” is the identical figure for original cost depreciated in the previous table.1 It is that item upon which the rate in this case has been fixed, and not the statutory base which was $14,004,182. His next step was to determine the amount of the book common equity. That figure, as appears in the table above, is an accounting figure which is reached by a subtraction of Entex’s debts (notes, bonds and preferred stock) from the original cost depreciated. That is what the examiner’s figures show. He arrived at the value of book common equity by using 100% of the original cost depreciated.
The examiner’s report to the Commission stated that book common equity was $1,800,523 and that the interest on Entex’s debts was 6.84% (rounded) which called for a required return of $243,258. The report showed that the examiner recommended a 17.6% (rounded) return on the $1,800,523 which would produce a return of $316,909. *302The required return would be the total of those two figures or $560,167. The importance of quoting these precise figures is that the Commission, by its adoption of the examiner’s exact figures, to the penny, has adopted the examiner’s report and recommendation, including his non-statutory method which looked alone at the original cost depreciated rate base and at 100% of that base.
The Commission adopted the examiner’s exact recommended return by ordering that Entex could recover a dollar return of $560,000. It then obscured its method for fixing the return on the non-statutory original cost depreciated rate base. Again, we go to the forthright statement of the examiner which shows how the original cost method was transmuted into a statutory facade by couching it in the language of section 41. With emphasis again upon the exact figures deduced exclusively from the original cost depreciated method, the examiner found:
A 4% return on the rate base (adjusted value rate base) produces a required return of $560,167 and when the interest expense of $243,258 is deducted therefrom, the amount left to be applied to the book common equity (computed at 100% original cost depreciated) results in a return of 17.6%. [Parenthesis added.]
This wrongful use of the original cost depreciated as the rate base is further evidenced by this part of the examiner’s report:
The difference of opinion regarding rate of return represents the elemental and fundamental gap between the parties in this proceeding — that of determining a rate of return on the utility’s rate base or beginning such an inquiry based on return to book common equity. [Emphasis added.]
Entex, in other words, took the position that the Public Utility Regulatory Act called for a rate based upon the utility’s adjusted rate base. That position was surely a reasonable one since the applicable statute so states. The City took the position that the root question was a determination of the return to book common equity. If that be the rule, the statute does not say so. Book common equity is reached, not by determining the adjusted value base; it is reached by determining 100% of the original cost depreciated.
The Commission adopted the examiner’s finding to the dollar and concluded:
3. A 4% rate of return amounting to $560,167 on the fair value base of $14,004,182 is a fair and reasonable rate necessary for the Entex Beaumont distribution system to contribute to the maintenance of the financial integrity of Entex, Inc. and to allow for the attraction of new capital.
It would have been equally wrong if the Commission had made a similar exclusive use of the other component of the statutory rate base — 100% of the current cost with adjustments [sec. 41(a)]. If the examiner had used only that component of the rate formula, the common equity would have been greatly enhanced above the book common equity figure of $1,800,523. These are the figures for the current cost with adjustment.
Entex Capital Structure
(100% Current Cost Adjusted)
Debt (Notes & Bonds) $ 3,558,549 6.84 $243,258
Common Equity 23,309,648 - 316,909
TOTAL CAPITAL $26,868,197 $560,167
If the Commission had used both components under the statutory scheme, that of original cost less depreciation and current cost less adjustment, and if it had used the statutory 60/40 ratio of the two, we would have had this fair value common equity:
Entex Capital Structure
(60/40 Ratio of Original Cost & Fair Value)
Debt $ 3,558,549
Fair Value Common Equity 10,445,638
TOTAL CAPITAL ADJUSTED RATE
BASE $14,004,187
Sections 39-41 state that the return shall be not more than a fair return upon the fair value common equity. The return should be computed upon fair value common equity which comes from the infusion of 40% of *303the current cost less adjustments. When the examiner and the Commission proceed in rate hearings to fix rates upon book common equity, they render sections 40 and 41 superfluous. If the Commission may fix a return based upon book common equity which is 100% of the original cost depreciated and if it determines, as it did in this case, that the return on book common equity is the maximum or ceiling for dollar return, it disregards the statutory scheme. That method is the same as it would have been without the enactment of sections 40 and 41 and the adoption of the rule which authorizes a fair return on fair value.
Once the wrong rule is used, it is easy to clothe the order in statutory language. All that need be done is to select the return on original cost depreciated and then translate the rate into any adjusted value that one might choose. For example, if the Commission decided that a fair return would be $560,000, expressing that return as a percentage of the lawful adjusted value would be a matter of simple arithmetic, as this schedule demonstrates:
Rate Base «14,000,000 *9,333,333 *7,000,000 *5,600,000
Rate of Return 4⅞ 6⅞ 8% 10%
TOTAL REVENUE $ 560,000 % 560,000 $ 560,000 $ 560,000
Recall that the 4% yield on the adjusted value rate base ($14,004,182) would pay the fixed cost of the debt ($243,258) plus a 17.6% return of $316,909 on book common equity. However, a $316,909 return on fair value common equity ($10,445,638) would amount to a percentage return of only 3.03%.
The legislative scheme contemplated the return on the fair value — not original cost. This precise problem of legislative adoption of a fair value rate was discussed in State ex rel. Utilities Commission v. Duke Power Co., 285 N.C. 377, 206 S.E.2d 269, 279 (1974):
Here, too, the Commission and this Court are bound by the provisions of G.S. § 62-133(b). The concept therein contained of a fair rate of return on the fair value of the properties used in rendering the service clearly contemplates the allowance of a greater dollar return than would be allowed if the rate base were the original cost, depreciated, of the same properties, assuming, as is here true, that the value of the properties has been enhanced by inflation. Otherwise, the exceedingly costly and laborious determination of “fair value,” as distinguished from original cost, depreciated, would be a meaningless exercise. It is not for the Commission, or for this Court, to evade the mandate of the statute by determining the number of dollars which would be a fair return on the original cost, depreciated, and then simply translating that amount into a percentage of “fair value.” [Emphasis added.]
The reasoning of Duke is persuasive. Our legislature did not require a determination of the section 41(a) rate base for naught. The legislature meant, by requiring the rate base to include an element of replacement cost, that Texas utilities should recover more revenue than they would have recovered if the rate base were valued 100% at original cost depreciated. Section 41(a) means something. If a regulator need only give a utility the section 39 floor revenues, then why determine an adjusted value rate base? Why not just multiply the original cost rate base by the composite percentage cost of capital established by expert testimony? We could simply forget section 41(a) and save ourselves the trouble of determining an adjusted value rate base. Of course, Southwestern Bell Tel. v. Public Utility Commission, 571 S.W.2d 503 (Tex.1978), requires a regulator to use the section 41(a) rate base in arriving at permissible revenue.
Again, a return sufficient to attract ample capital, if that is all there is to the rule, may always be translated into a percent of an adjusted value rate base. Such an approach to utility regulation, however, does not grant a utility “any return on the difference in value between the adjusted value of invested capital and original cost.” Bell, at 514. It seems that by requiring a regulator to determine an adjusted value rate base, the legislature intended utilities to earn some return on this difference. The correct statutory rule is that the return must be a fair return on the adjusted value, *304which is the only rate base under sections 39 — ál, PURA. Expert opinion about rate of return should have been addressed to that base, rather than to the unlawful original cost depreciated or to book common equity. It is the adjusted value rate base upon which the rate of return applies, for “By that standard the return to the equity owner should be commensurate with the returns on investments in other enterprises having corresponding risks.” Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944).
Texas follows the fair value concept in rate making. General Telephone Co. of the Southwest v. City of Wellington, 156 Tex. 238, 294 S.W.2d 385 (1956); City of Arlington v. TESCO, 540 S.W.2d 580 (Tex.Civ.App.—Fort Worth 1976, writ ref’d n. r. e.); City of Athens v. Gulf States Telephone Co., 380 S.W.2d 687 (Tex.Civ.App.—Tyler 1964, writ ref’d n. r. e.); City of Weslaco v. General Telephone Co. of the Southwest, 359 S.W.2d 260 (Tex.Civ.App.—San Antonio 1961, writ ref’d n. r. e.); San Antonio Transit Co. v. City of San Antonio, 323 S.W.2d 272 (Tex.Civ.App.—San Antonio 1959, writ ref’d n. r. e.). In Bayou Pipeline Corp. v. Railroad Commission, 568 S.W.2d 122 (Tex.1978), we upheld the Commission’s order setting an 8% return on fair value of a gas transmission line, and in doing so we held that “the Commission arrived at this rate by determining a fair return on the fair value rate base of Bayou’s transmission properties. This was in line with the standard which is codified in PURA, art. 1446c . .” That is a correct rule of law. In Southwestern Bell Tel. v. Public Utility Commission, 571 S.W.2d 503 (Tex.1978), we approved an 8.37% return on the statutory rate base of adjusted value of invested capital.
Entex has not received any rate increase. As a result of these proceedings, it has received a rate decrease as appears both from the examiner’s report and the letter of transmittal by the examiner. As stated by the examiner:
As I stated to you previously, I want to make you aware that the rate of return which I have recommended to the fair value rate base for Entex is 4% which results in a rate of return on the book common equity of 17.6%. This case is the first departure from an 8% return to the fair value rate base in some time but it is my feeling that the Commission is now interested in looking at the return to book equity when it is excessive and the application of an 8% return to Entex’ fair value rate base would result in a 48% return to the book equity which I would consider to be excessive. The 17.6% return to the book equity which results from a 4% return on the rate base is somewhat under the 21% average return to book common equity of Entex, Inc. during that last five years.
The recommendation, as we have seen, was followed and for the first time in some time, the Commission departed from its award of 8% on adjusted value. It granted only a 4% return. In doing that, it reduced Entex’s return from a 21% return on book common equity that Entex was already receiving to 17.6%.
So long as the statutes require a fair return on fair value rather than original cost, the examiner’s report has no legal basis. As was stated in State ex rel. Utilities Commission v. Duke Power Co., 285 N.C. 377, 206 S.E.2d 269, 279 (1974):
It is not for the Commission, or for this Court, to evade the mandate of the statute by determining the number of dollars which would be a fair return on the original cost, depreciated, and then simply translating that amount into a percentage of “fair value.”
The Texas statute authorizes a return on fair value which almost always exceeds a fair return on original cost. See Duke Power Co., supra.
State utility regulation is new to this jurisdiction, but the question presented by this appeal has been resolved in other jurisdictions with more experience. The problem is not solved by the examiner’s and Commission’s asking the wrong question. It is wrong to ask what return will attract capital upon a rate base of original cost *305depreciated. The legislature has posed for the Commission a different but clear statutory question: What rate of return will attract capital upon the adjusted value rate base — not the original cost; and upon the fair value common equity — not the book common equity? State ex rel. Utilities Commission v. General Telephone Co. of the Southeast, 281 N.C. 318, 189 S.E.2d 705 (1972); Ohio Edison Co. v. Public Utilities Commission, 173 Ohio St. 478, 184 N.E.2d 70 (1962).
The Commission’s order was clearly grounded upon a return upon the wrong rate base, as was conclusively shown by its approval of the examiner’s disregard for the fair value rate base.
The Commission substituted its own non-statutory standard for the fair value rate base. It denied Entex any return upon its fair value rate base.
I would affirm the judgment of the district court.
GREENHILL, C. J., and McGEE, J., join in this dissent.
GARWOOD, J., not sitting.

. Net Original Cost $5,255,422
Plus: Construction Work in Progress $12,284
Working Capital 91,366
103,650
TOTAL CAPITAL $5,359,072