Court Opinion

ID: 9584350
Source: CourtListenerOpinion
Date Created: 2023-08-21 22:47:11.629868+00
Date Added: 2024-06-11T15:07:37.387812
License: Public Domain

Neely, Chief Justice,

Concurring:

I concur in the result reached by the majority that this case should be remanded for further development; however, I feel that this opinion may contribute to proper development on remand. The circumstantial evidence in this case of an inadequate rate of return to the utility is so compelling that I believe that the Commission will have little choice but to avail itself of the opportunity suggested at the conclusion of the majority opinion to modify its order.
I have very few illusions about my own limitations as a judge and from those limitations I generalize to the inherent limitations of all appellate courts reviewing rate cases. It must be remembered that this Court sees approximately 1,262 cases a year with five judges. I am not an accountant, electrical engineer, financier, banker, stock broker, or systems management analyst. It is the height of folly to expect judges intelligently to review a 5,000 page record addressing the intricacies of public utility operation. As we have implied in Virginia Electric and Power Co. v. Public Service Commission, 161 W.Va. 423, 242 S.E.2d 698 (1978), cited with approval in Virginia Electric & Power Co. v. Public Service Commission, 161 W.Va. 423, 248 D.R.2f 322 at 327 (1978), the one critical result which courts can understand and the only thing which they need address is the constitutionality of the utility’s rate of return on its invested capital. Courts are indispensable to the health of regulated industries in this regard since they are expected to be uninfluenced by political considerations which may cloud the judgment of elected officials and their political appointees. Certainly a public utility has as much right under the Fourteenth Amendment to the Constitution of the United States and W. Va. Const., art III, § 10 not to have its property confiscated as the lowliest welfare client.
I.
It is to the issue of confiscation that the public utility has addressed itself in its presentation of the case before us; *441unfortunately, that was not the thrust of the utility’s case below so that the evidence in support of their position is very raw. Nonetheless the utility has enough«evidence to create serious concern for its continued solvency. The historic rate of return to equity stockholders from 1971 to 1979 is depicted in the graph below:

Facts supporting that graph were introduced into evidence by the utility and the graph was made a part of the utility’s brief. On reargument before this Court on 12 November 1980 I asked counsel for the Public Service Commission whether the Commission would stipulate that the graph is accurate and counsel said that while the Commission would not stipulate its accuracy, the Commission did not assert that it was inaccurate. The dotted line which shows a decline from 1979 to 1980 is the utility’s estimation of the probable further decline for the year 1980 and there is *442nothing in the record before us to indicate that the utility’s prediction is not substantially accurate.
It is upon these figures which show a consistent decline from an 11.9 percent rate of return to equity in 1974 to a 7.4 percent rate of return to equity in 1979 that the utility may have made its case. As we shall see below, however, there is some question about what the utility has included in its rate base to arrive at these figures; the Commission’s expert testimony is at odds with these figures but not sufficiently developed to be persuasive. The testimony of neither utility nor commission witnesses discusses the methodology employed to determine the rate base upon which the rate of return was calculated although there is random discussion of the rate base. Consequently, the factors to which I am looking are not the exact figures submitted by the utility, but rather the trend. If there were consistent miscalculations in the determination of the proper rate base, the best case for the Commission would merely move the entire trend line upward and to the right, leaving the downward thrust intact.
While the utility may have included some questionable items in its rate base, such as construction works in progress, nontheless, we can reasonably assume that whatever accounting conventions were used have been used consistently. Accordingly, it is the consistent downward slope through good years and bad which demonstrates a questionable system of rate regulation. The most salient feature of the utility’s graph is that it does not show positive and negative fluctuations around an acceptable mean; quite to the contrary, it shows a six year course of consistent decline. Some of this decline may be attributable to a year by year increase in attrition along with a constantly expanding requirement for construction for new capacity; however, as we shall see when the market value of the parent’s stock is discussed, there appears to be no general expectation outside the Commission that this company will ever harvest a reasonable profit from its current construction. That implies that any accounting *443explanation for a low rate of return is somewhat ingenuous.
II
The legal guidelines which have long been established criteria for determining the reasonableness of rate of return have rarely been used to overturn a regulatory decision on the basis of unreasonable rate of return. Under Bluefield Water Works & Improvement Co. v. West Virginia Public Service Comm’n, 262 U.S. 679 (1923) and Federal Power Comm’n v. Hope Natural Gas Co., 320 U.S. 591 (1944), the return must be sufficient to: (1) maintain confidence in the financial integrity of the enterprise, (2) maintain the credit of the enterprise, and, (3) attract capital to the enterprise by affording it an earning opportunity commensurate with returns on investments in other enterprises having corresponding risk. More recently, the United States Supreme Court announced its rules for review of administrative appeals in Permian Basin Area Rate Cases, 390 U.S. 747 (1968) which is reflected in the majority’s syl. pt. 2. There is serious concern on my part whether the old guidelines or the Permian Basin guidelines have been met as will become apparent when we discuss: (1) the market value of the parent company’s stock (which is significantly below book value); (2) the downgrading of Monongahela’s bond rating; and, (3) the substantiated allegations that the method of arriving at rates through the use of an unrealistic test year will always put real rates behind systemic inflation.
A
If the utility were suffering from only the effects of an adverse business climate on a casual basis, it would be proper for the Commission to conclude that the utility, like any other private business, must be ready to accept good and bad years in response to fluctuations in demand for its particular product. Notwithstanding the eloquent arguments of the Commission that Monongahela’s poor performance is attributable to such factors as decreased *444sales to other utilities, the record does not show that the alleged confiscatory return to equity in the case before us emanates primarily or even substantially from the nature of demand. Even if all of the conclusions of the Commission about a decline in profit attributable to reduced sales were true, the utility calculated rate of return for 1979 would increase from 7.4 percent to only 8.4 percent, and upon oral argument, in response to my questions, the Commission did not challenge that the change would be of that general order of magnitude.
While there may be a short run advantage to consumers to maintaining confiscatory rates for public utilities it is certainly not to their long run advantage. According to undisputed testimony, Moody’s Bond Service recently downgraded the bonds of the Monongahela Power Co. from A to Baa. It should be obvious even to a novice that the downgrading of bonds by a rating service implies higher rate of interest for borrowed, fixed obligation securities, which must ultimately be absorbed by consumers.
The utility has made a persuasive case that it is unable to raise capital because of: (1) its inability to provide adequate “coverage” for either bonds or preferred stock; and, (2) its inability to pay dividends on common equity. No new bonds can be issued unless the annualized aggregate interest on existing first mortgage bonds plus the anticipated annualized interest on the proposed new issue bonds is “covered” twice by earnings as defined in the utility’s indenture.1 According to a chart submitted by the utility to which the Commission stipulated in principle (assuming the mathematics were correct) the company is currently unable to issue $50 million of new bonds because its coverage will not support the issue.
Furthermore, even when the company is legally in a position to issue first mortgage bonds under its indenture, *445that legal ability does not dictate the cost of capital. The amount of money which can be raised is some direct negative function of the interest rate since as the cost of capital increases in response to rating service downgrading, the amount of bonds which can legally be issued under existing coverage decreases. Preferred stock also has coverage restrictions, in this instance a one and one-half coverage requirement; therefore, earnings must be one and one-half times annualized interest costs and annualized dividends on existing preferred stock plus the annualized dividends on the proposed preferred stock before the proposed preferred stock can be issued. The mere existence of legal coverage, however, does not determine whether the market will accept the new issue or at what cost.
Finally, we come to common equity. The Monongahela Power Company is a wholly-owned subsidiary of the Alegheny Power System; therefore, Monongahela’s only source of equity financing is the parent company. Allegheny Power cannot invest equity capital in Monongahela unless it raises equity capital itself and Allegheny can only raise equity capital by selling its own common shares. It should be obvious that Allegheny cannot issue common equity without supporting it by dividends and it can pay dividends only from funds which it receives as dividends from its operating subsidiaries. Furthermore, from the perspective of consumers of electric power in West Virginia there is a need to assure that the company will be able to raise the necessary capital to meet projected increased demands for electricity.2
*446B
The thrust of the utility’s complaint is that the method by which the Public Service Commission sets rates is entirely unrealistic and will not only deny the utility a fair rate of return in this case, but will also deny it a fair rate of return for the foreseeable future. The utility maintains that setting rates by reference to a test year (in the case before us the year 1977) leads to inherently absurd results because inflation makes the figures developed by reference to a test year obsolete immediately.
This Court cannot, of course, become involved in the accounting mechanics of rate setting; however, the evidence before us, tied as it is to rate of return, presents a persuasive body of circumstantial evidence that the Commission is doing something very wrong. While I would not presume to discuss the mechanics of rate setting, I think that the circumstantial evidence which follows is *447sufficient to require further inquiry and explanation concerning the Commission’s procedures, since the circumstantial evidence indicates that the Commission is in substantial error. In this regard the Commission’s own expert witness filed the following chart for the Allegheny Power System which demonstrates that consistently since 1974 the price per share of Allegheny Power System stock has been significantly below the book value:
ALLEGHENY POWER SYSTEM, INC. INDICATORS OF COST OF CAPITAL
No. Description 1978 1977 1976 1975 1974 5 Year Average
1 Earnings Per Share (?) 190(1) 2.28 218 232 1.76
2 Dividend Per Share ($) 1.72 I.69 1.62 154 1.52
3 Book Value Per Share (?) 20 54(2) 20.43 1995 19 49 18.78
4 Market Value Per Share (?) 18.27(3) 21.08 19.19 16.59 16.67
5 Earnings/Book Value (%) 9.25 II.16 10.93 1190 9 37 10.52
6 Earnings/Market Value (%) 10.40 1082 11.36 13.98 1058 11.43
7 Average Annual Dividend Yield (%) 9.41 8.02 8.44 9.28 912 8.85
8 Dividend Payout Ratio (%) 90.53 74.12 74 31 66 38 8636 78.34
9 Market Value/Book Value (%) 88.95 103.18 96.19 85.12 88.78 92.44
10 Average Number of Common Shares Outstanding (000) 38,483 62(1) 30,928.02 30,256.71 27,29223 26,894 97
While the commission expert did point out that Monongahela Power performed significantly better than other companies in the Allegheny system, nonetheless, it should be obvious that if Allegheny issues new equity capital at a sales price less than book value, the effect is to reduce the equity of existing shareholders since the new shareholders are buying in at almost fire sale prices.
Since a public utility has an obligation to serve the public, existing shareholders are in imminent danger of having their property confiscated through no process other than the utility’s moral obligation to raise equity capital to finance capacity needed by the public. From a reading of the exhibits submitted by both the Commission’s staff and the utility I am, quite frankly, unable to determine the *448extent to which the performance of the Monongahela Power Company bears responsibility for the inadequate price of Allegheny Power System shares. If upon remand it can be demonstrated that Monongahela Power Company’s performance does not contribute to the poor performance of the parent’s stock, then, obviously, West Virginia has no obligation to compensate for inadequacies in either Ohio or Pennsylvania.
The testimony of the Commission’s staff and experts would lead me to believe that the Commission’s criteria for a fair rate of return are erroneous since the staff consistently asserts that the standard is the rate of return of other regulated utilities. No reasonable political economist would accede to the proposition that one regulated enterprise should be judged by reference to another regulated enterprise. That criterion would quickly lead us down the path to Alice’s Wonderland. Certainly the rate of return allowed other power companies is one element to be considered, but the primary criterion must be the rate of return earned by large companies in the unregulated, market economy engaged in the manufacture of a product for which there is a stable demand. This is almost the definition of “fairness” because investors are entitled to the same return in a regulated industry that they would receive for a comparable risk in the unregulated sector. In this regard it is difficult to find a perfect market sector model for rate making purposes; nonetheless, a composite model can be constructed with skillful econometrics using available statistical material. Otto Eckstein at Harvard has made his reputation doing such things. It is eminently unfair to the utility to be judged by the standard of other utilities since the preeminent risk shared by all public utilities is political and not economic, the exact risk against which public service commissions and courts are expected to insure.
Since the Commission’s staff cited to the Value Line Investment Survey in the preparation of its testimony, I take the liberty of pointing to the chart below which is *449Value Line’s list of high yielding stocks published 16 January 1981:

*450It is interesting to observe that with the exception of South African companies, almost all of the highest yielding stocks are public utilities. For the reader who is unfamiliar with the stock market, this means that the value of the stock is among the lowest in America as a multiple of dividends. In other words utility stock has been a poor performer as a long term investment. High yield usually means that the stock market is compensating for the stocks’ lack of attractiveness in terms of growth, product innovation, or future profits attributable to other factors; in other words, it takes a very high current pay out to attract stock buyers since the long term prospects for higher profits are so dismal. In general institutional investors consider utility stock a sucker’s bet.
One explanation of the current high yields is that utility stock tends to reflect the movement of the bond market (thus when interest rates are high the value of the stock is low). While the argument that the value of utility stocks will always move in an inverse direction from interest rates sounds eminently reasonable, that does not account for the fact that when interest rates were comparatively low from 1974 to 1976 the stock of Allegheny Power, the parent utility, still sold well below book value. If the argument is made that when all stocks do badly, as was the case from 1974 to 1977, utilities will also suffer, then there is no logic at all to the first proposition that utility stocks move with the bond market since when the stock market was low during those years the bond market was thriving. Those who argue that a low stock price is a normal risk to private enterprise which has no relation to an unfair rate of return must elect upon which theory they wish to proceed, but they cannot proceed on inconsistent theories simultaneously. It is not pure accident that utilities in general share the same page in Value Line with South African companies. Both utilities and South African companies suffer from political risk, by far the most threatening of all risks which can be borne by business. When the maintenance of low utility rates is an urgent item on political agendas throughout America it is hardly good methodology to use one confiscatory utility rate to determine another.
*451C
Notwithstanding that I believe that the utility has made a good circumstantial case, it does not appear that upon the current record the utility has conclusively demonstrated anything other than a likelihood of confiscation. On remand, however, the Public Service Commission and the utility should explore what an appropriate “fair rate of return” is in this economy and the methodology by which that figure can be developed. Furthermore, it has always been admitted that the actual performance of a public utility may fall below the fair rate of return allowed by the Public Service Commission if such decline is the result of bad management, peculiar economic conditions of short duration, or an ill-advised investment decision. There is, as indicated earlier, evidence in the record that part of the poor performance of the utility is attributable to lack of demand by other power systems for surplus power which Monongahela expected to generate and sell. This may be a risk which should legitimately be borne by the utility, but that is only the case if the Commission concludes that in a year when the company sells in excess of the amount of power expected it will be entitled to keep the profits. Previous cases in this Court for which there are no reported opinions because petitions for review were not granted instruct my understanding that the Commission is most parsimonious in allowing utilities any windfall profits. The cases which leap to mind concern certain tax credits which Commission required to be passed through to consumers. Certainly in light of the Commission’s care in determining that all reductions in cost should be passed on immediately to consumers, the argument that utilities must bear all the consequences of a poor economy are a little ingenuous. I voted to deny review to the utilities in the cases I recall because the Commission’s policy seemed reasonable; that policy still seems reasonable, but like all rules of policy and law it should not be applied in only one direction.
The effect of pollution abatement expenses, pervasive inflation, increases in the cost of fuel, and similar problems which are plaguing public utilities must be considered risks to be borne by the rate payer. A market-sector enterprise *452faced with similar problems would either increase its prices or go out of business; the latter option, however, is hardly a viable one for a public utility. A public utility, in fact, must constantly expand its business. Certainly no reasonable commission would tolerate a significant reduction in the cost of service unaccompanied by a significant reduction in rates. If, for example, Professor Bardine at the University of Illinois were to perfect super-conductivity technology by which electricity could be transmitted over long distances with almost zero resistance, and as a consequence the cost of maintaining an electric power distribution system dramatically fell, it is obvious that the Public Service Commission would require commensurate rate reductions. While public utilities must be insulated from losses beyond their control they are similarly insulated from any opportunity to make a profit in excess of “a fair rate of return,” and this fact would explain a natural tendency of utility stock to move with the bond market. It does not explain, however, the tendency of utility stock not to move upwards at all.
On remand, therefore, an order and a supporting record if necessary should be developed which addresses the following issues: (1) what is a fair rate of return to a public utility and what is the methodology by which that rate of return is determined; (2) what business risks and opportunities for profit are appropriately allocated to the utility and what risks are appropriately allocated to the rate payer; (3) is the current method of setting a rate for this utility by using an adjusted test year a realistic system of rate regulation and, if not, what system will be realistic; and (4) what is the long-term effect of the actual current rate of return for the company with regard to its ability to meet its need for capital in the immediate future?
D
There is one final issue which I feel compelled to address and that concerns the inclusion or noninclusion of construction works in progress (CWIP) in the rate base. The first chart on rate of return, supra, does not refine the degree to which CWIP has been included by the company in its calculation of the rate base. Certainly it would seem *453logical that to the extent CWIP is devoted to pollution abatement, a project which uses rather than generates electricity, its immediate inclusion is in order as a cost not recoverable in future operation. In effect, the Commission has already recognized this fact and included some CWIP in the rate base in the case before us. Unfortunately the record in the case before us is not sufficiently refined for me to make any exact computations about the rate of return which would apply in the absence or inclusion of CWIP for profit generating equipment. The Commission’s expert witness on rates of return projected the utility’s rate of return substantially higher than the utility’s figures but he was not cross examined and, therefore, the issue of what CWIP has been included in rate base has not been developed sufficiently for any further factual analysis on my part.
Ordinarily, a private, market-sector enterprise cannot expect to make a profit on money which is tied up in the construction of new plant and equipment before that plant and equipment is in operation. A market-sector firm, however, expects that the interim financing charges allocated to the construction of the new plant will be recovered through increased profits in the future. That, in fact, is the very nature of investment. There is no debate that the utility needs to construct new plants so that such construction cannot be considered a stupid investment. In general, when a company is investing intelligently the market value of the stock reflects a market expectation of larger profits in the future. Why then does the company’s stock sell below book value? Obviously the market performance of this utility’s stock confounds our expectations about how current investment aimed at future profits should affect the attractiveness of the stock. Obviously someone out there in stockholder land does not believe that the utility will ever be permitted to earn a fair return on its current CWIP investments, otherwise the stock would not be selling below book value. While stockholder land is not infallible in its conclusions, institutional investors are at least as sophisticated as the Harvard Business School, and that gives the stock market about as heavy a presumption of accuracy in those matters as the average jury.
*454The issue of CWIP recurs throughout major utility cases primarily because the inclusion or exclusion of that factor in the rate base can be manipulated by the company to give a very high current profit or by the Commission to give a very low one. In fact the rate payer under any fair set of regulations will either pay the cost of these projects today while they are being built or tomorrow when they are in service. Given the overall problems of the utilities in raising funds it is certainly worth exploring in the record the possibility of adopting a pay-as-we-go program which will enhance the overall profit picture of the utility at the present time and permit the issuance of bonds or preferred stock at a significantly reduced cost in the future.3 Since the issue of the inclusion of construction works in progress in the rate base goes directly to the heart of the “fair rate of return” question, it is one of the few issues so inextricably intertwined with that issue as to be fit subject for exhaustive development below and reconsideration by this Court.
III
I would conclude with a general observation about the development of these types of cases in the Commission. Obviously, in this time of intense struggle over income shares there is a significant possibility that business will be sacrificed because of its relative lack of votes in the political process and its attractiveness as a target for rhetorical attack. Thus, like everyone else in society the last refuge for business is the courts. Accordingly, the courts must review with ever greater frequency rate regulation cases and this implies that counsel below pay attention to making a record which can be understood by judges who are not experts.
The record before this Court contains thousands of pages of exhibits and submissions without cross examination which I, for one, cannot understand. I do not doubt that the Commission can understand them because that is what public service commissions are all about. The lack of *455cogency of this opinion emanates from the lack of cogency of the record before me. I have the nagging feeling that lawyers arguing rate regulation cases in this Court proceed on the principle that if you can’t dazzle the Court with brilliance, you can at least baffle them with nonsense. I don’t like that feeling because it makes me think that I am stupid.
In the future I shall take it very ill if thousands of pages of repetitive testimony are placed in a record when one cogent witness, intelligently cross examined, would suffice. It should be remembered that the term “weight of the evidence” does not imply measurement in pounds. Futhermore, it is in the interest of both Commission and utility to designate a record, print it separately in one comprehensible volume with pagination which the country average judge can follow, and narrow the issues to things which a court can understand. Often the party which thinks that it will prevail by sheer weight of nonsense is enormously uncooperative about designation and narrowing of issues; this is both ungentlemanly and, at least in my chambers, will cause an enormous amount of conscious bad will towards those who deliberately attempt to confuse issues. When either party has just reason to believe that the other is uncooperative in this regard, efforts to make a manageable record should be made a part of the record themselves so that the Court can impose sanctions on the recalcitrant, obstreperous, or inconsiderate.
It is also a misconception to believe that this Court, which is an organized, collective intelligence composed of a range of talent which exceeds as an entity the talent limitations on the judges alone, cannot understand the methodology of economics, including the underlying calculus and statistics. Rate regulation is enormously taxing intellectually and in this one area it appears to me essential that the lawyers trying the case have some formal training in mathematics, statistics, and economics. While I consistently point out that a court is not competent to understand nit-picking accounting conventions or other points of traditional haggling between commissions and utilities, we can understand rate of return. In that regard we can understand everything about rate of return; the statistical *456method used to determine the rate base; the econometrics of models simulating rates of return to comparable market sector enterprises; and all of the movements in the capital market which bear upon a utility’s ability to raise funds. Consequently, these issues should be developed with some precision. Legal skills are important in developing cases of this type, but counsel capable of skillful development of expert testimony is even more important and that is not a legal skill, but rather the result of understanding on the part of the lawyer of the expert’s field. Rate regulation cases are not competitions between lawyers to see who can insert the greater volume of junk which they do not understand themselves in the record. If the lawyer asking the questions doesn’t know the answer to the questions being asked and understand the methodology from some background of formal training, he will hardly be able to organize or illuminate the record. If in future appeals in this Court a lawyer arguing the case for either side cannot explain one piece of evidence in the record I shall leave. It is no excuse for appellate counsel to argue that he “didn’t try the case below.” When garbage goes into a case garbage comes out!

 Under section 79(f) of Title 15 of the Public Utility Company Act of 1935, no company subject to the provisions of the Act shall issue or sell its first mortgage bonds or preferred stock except in accordance with a “declaration” as that term is defined elsewhere in the Act.

 Our own Public Service Commission advised the Legislature in its 1980 Report to the West Virginia Legislature; Electric Supply and Demand Balance, 1979-1989, that:
Of all the major electric utilities located in this State, MPCO [Monongahela] and PECO [Potomac Edison Company] have the worst outlook regarding their capability to serve their projected load. With the present load and capacity projections and if any generations outages occur during peak load, APS will not be capable of providing from its own generation the total power requirements of its customers duringthe period 1984 through 1987. After that period, APS’s ability to supply their customers’ loads *446will depend on when and if it is successful in installing the Lower Armstrong, David Hydro and subsequent units. Should APS not be able to install this generation at the projected ‘in-service’ dates, the power supply to the northern two-thirds of the State will he very precarious.” (Emphasis supplied).
The financial instability of electric utilities has recently become a source of ever greater national concern. Some observers warn that the unprecedented and once thought impossible may occur: a major U.S. utility could fall into bankruptcy. The greatest problem facing electric utilities is unquestionably the soaring cost of construction which has grown astronomically in recent years. At the same time the average utility’s ability to generate money internally has dropped steadily. While utilities have traditionally paid large dividends from net income and cash earnings, they are now forced to rely on other sources, such as a depreciation fund or bank borrowing. Another problem is that the portion of net income which is designated as allowance for funds used during construction (AFUDC) has grown rapidly. While AFUDC is a perfectly acceptable accounting principle, it doesn’t help utilities pay bills and it pushes up apparent earnings which increase consumer resistance to higher rates.
The loss in confidence by investors in public utilities is best reflected in the drop in their credit rating. While in 1970 only 4% of the electric utilities received the lowest investment grade rating, today fully 30% of the electric utilities have received the lowest grade from Standard & Poor’s. For a discussion in more detail, see Emshwiller, “Big Financial Problems Hit Electric Utilities, Bankruptcies Feared”, Wall St. J., Feb. 2, 1981 at p. 1, col. 6.

 For a recent discussion of this issue see Commissioner Elwin Bresette’s dissent in case No. 80-058-E-42T, a consideration of rate increase for Monongahela Power Company, filed January 14, 1981.