City of Evansville v. Southern Indiana Gas & Elec. Co.

• Decision Date: 30 December 1975
• Docket Number: AFL-CIO,No. 272A89,272A89
• Parties: CITY OF EVANSVILLE andCentral Labor Council of Vanderburgh et al., Counties, Appellants (Intervenors below), v. SOUTHERN INDIANA GAS AND ELECTRIC COMPANY, an Indiana Corporation, et al., Appellees (Petitioners below).
• Court: Indiana Appellate Court

Page 562

339 N.E.2d 562

167 Ind.App. 472

CITY OF EVANSVILLE and AFL-CIO Central Labor Council of

Vanderburgh et al., Counties, Appellants (Intervenors below), v. SOUTHERN INDIANA GAS AND ELECTRIC COMPANY, an Indiana

Corporation, et al., Appellees (Petitioners below).

No. 272A89.

Court of Appeals of Indiana, Second District.

Dec. 30, 1975.

Opinion Concurring in Part, Dissenting in Part Jan. 12, 1976.

Paul Hirsch, Virginia Dill McCarty, Indianapolis, Sydney L. Berger, Cox, Schroeder, Dodd, Staser & Mitchell, Evansville, for appellants

Theodore L. Sendak, Atty. Gen., Executive Secretary of the Public Service Commission of Ind., Leslie Duvall, Carl E. Van Dorn, Public Counselor, Indianapolis, Fred P. Bamberger, Bruce R. Heathcotte, Bamberger, Foreman, Oswald & Hahn, Evansville, for appellees.

STATON, Presiding Judge.

The Southern Indiana Gas and Electric Company (Petitioner) instituted this proceeding on May 7, 1971 before the Public Service Commission (Commission) for the purpose of obtaining an increase in its electric service rates. Petitioner is engaged in the production, distribution and sale of electric power to consumers in the southwestern portion of Indiana. The Petitioner's proposed electric rate schedules were designed to increase its electric operating revenue by $4,898,060.00, and to provide a return on investment of $8,150,429.00. The aggregate amount of proposed rate increase for all classes was 16.8 percent.

Before the formal hearings on the rate increase, the City of Evansville (City) and the AFL-CIO Central Labor Council of Vanderburgh, Posey and Warrick Counties (Council) petitioned for leave to intervene in Petitioner's rate proceeding. The Commission granted both intervention petitions, and the Intervenors actively participated in the formal hearings conducted by the Commission during October and November of 1971. On January 28, 1972, the Commission issued its final rate order, which increased Petitioner's rate income to $8,021, 405.00. The Commission's order resulted in an aggregate rate increase of approximately 16 percent.

The City and the Council have joined in initiating this appeal for a review of the Commission's order. Appellate jurisdiction is predicated upon IC 1971, 8--1--3--1 to --12 (Burns Code Ed.), which authorizes '(a)ny person, firm, association, corporation, city, town or public utility adversely affected by any final decision, ruling, or order . . .' of the Commission to seek judicial review in this Court. IC 1971, 8--1--3--1 (Burns Code Ed.).

We affirm in part and remand with instructions for further proceedings consistent with this opinion.

I. Rate Method

To place the issues raised by this appeal in perspective, it is necessary to provide the reader with some background on the methodology of rate regulation. The Commission's primary objective in every rate proceeding is to establish a level of rates and charges sufficient to permit the utility to meet its operating expenses plus a return on investment which will compensate its investors. IC 1971, 8--1--2--4 (Burns Code Ed.); Federal Power Comm'n v. Hope Natural Gas Co. (1944), 320 U.S. 591, 605, 64 S.Ct. 281, 88 L.Ed. 333. Accordingly, the initial determination that the Commission must make concerns the future revenue requirement of the utility. This determination is made by the selection of a 'test year'--normally the most recent annual period for which complete financial data are available--and the calculation of revenues, expenses and investment during the test year. ¹ The test year concept assumes that the operating results during the test period are sufficiently representative of the time in which new rates will be in effect to provide a reliable testing vehicle for new rates.

The utility's revenues minus its expenses, exclusive of interest, constitute the earnings or the 'return' that is available Test-year revenue and expense data, however, may not always provide a suitable basis for determining rates. Because of abnormal operating conditions such as unusual weather or atypical equipment outages, test-year revenues and expenses or both may not faithfully reflect normal conditions. If test-year results are unrepresentative, appropriate adjustments must be made to correct for the effects. ³ This type of adjustment is commonly labeled an 'in-period adjustment.' Since test-year results are relevant for a determination of utility rates only to the extent that past operations are representative of probable future experience, further adjustments are usually necessary to account for changed conditions not reflected in test-year data. For example, if future operations will be required to bear higher tax rates or higher levels of wages and salaries than were incurred during the test year, test-year data must be adjusted to reflect increased costs. This type of an adjustment to test-year data is usually referred to as an 'out-of-period adjustment.'

                to be distributed to the utility's investors.  2  Allowable operating costs include all types of operating expenses (e.g., wages, salaries, fuel, maintenance) plus annual charges for [167 Ind.App. 479] depreciation and operating taxes.  While the utility may incur any amount of operating expense it chooses, the Commission is invested with broad discretion to disallow for rate-making purposes any excessive or imprudent expenditures.  IC 1971, 8--1--2--48 (Burns Code Ed.)
                

After the utility's existing level of earnings or 'return' is established, the amount of investment in utility operations--the 'rate base'--is determined by adding the net investment in physical properties to an allowance for working capital. ⁴ The 'rate base' consists of that utility property employed in providing the public with the service for which rates are charged and constitutes the investment upon which the 'return' is to be earned. Since traditional rate-making methodology utilizes the 'historical' test year, the 'rate base' is usually defined as that utility property 'used and useful' in rendering the particular utility service. IC 1971, 8--1--2--6 (Burns Code Ed.). The property included in the 'rate base' may be valued by one of two standard methods: (1) the 'original cost' method, which is based on book value (the cost of an asset when first devoted to public service), or (2) the 'fair value' method, which takes into account the declining purchasing power of the dollar through 'reproduction cost new' studies utilizing price indices or other measurements of an investment's current value. ⁵ The Indiana statutory scheme authorizes the use of either valuation method. IC 1971, 8--1--2--6 (Burns Code Ed.).

After existing levels of 'return' and 'rate base' are determined, the Commission must decide whether the 'rate of return,' the ratio of 'return' to 'rate base,' is deficient, adequate, or excessive. The generally accepted method for establishing a comparative basis to determine the adequacy or excessiveness of the utility's existing 'return' is the 'cost of capital' approach. The Commission first examines the utility's capital structure to identify the sources of the utility's capital; the capital structure of an average electric utility might consist of 50 percent debt, 15 percent preferred stock and 35 percent common stock. ⁶ The Commission then ascertains the cost of each capital component: (1) the cost of debt, determined by comparing the utility's annual interest requirements with the proceeds from utility bond sales; (2) the cost of preferred '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.'

stock, determined by comparing the stated dividend requirements on outstanding preferred stock with the proceeds from preferred stock sales; (3) the cost of common stock, determined by the return required to sell such stock in prevailing capital markets. After these preliminary determinations are made, the Commission calculates a composite 'cost of capital' by taking a weighted average of the cost of each capital component. The composite cost of capital, when expressed as a percentage of the utility's combined debt and equity accounts, is then [167 Ind.App. 481] compared with the utility's existing rate of return, and thus serves as an initial point of reference in establishing a 'fair rate of return' for utility operations. The United States Supreme Court has delineated the legal criteria for determining a 'fair rate of return.' In Bluefield Waterworks & Improvement Co. v. Public Serv. Comm'n (1923), 262 U.S. 679, 692--93, 43 S.Ct. 675, 679, 67 L.Ed. 1176, the Court stated:

The 'fair rate of return' is usually the final subsidiary issue that the Commission resolves in determining the utility's revenue requirement. After considering all other issues, many regulatory agencies frequently employ the rate of return component as a 'balance wheel' to provide a limited margin of error for...