Distrigas of Massachusetts Corp. v. F.E.R.C., s. 83-1633

• Decision Date: 14 June 1984
• Docket Number: Nos. 83-1633,83-1728 and 83-1777,s. 83-1633
• Citation: 737 F.2d 1208
• Parties: DISTRIGAS OF MASSACHUSETTS CORPORATION and Distrigas Corporation, Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent. Boston Gas Company, et al., Intervenors. DISTRIGAS OF MASSACHUSETTS CORPORATION and Distrigas Corporation, Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent. Boston Gas Company, Intervenor. BOSTON GAS COMPANY, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent. Bay State Gas Company, et al., Intervenors.
• Court: U.S. Court of Appeals — First Circuit

Page 1208

737 F.2d 1208

DISTRIGAS OF MASSACHUSETTS CORPORATION and Distrigas

Corporation, Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.

Boston Gas Company, et al., Intervenors.

DISTRIGAS OF MASSACHUSETTS CORPORATION and Distrigas

Corporation, Petitioners, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.

Boston Gas Company, Intervenor.

BOSTON GAS COMPANY, Petitioner, v. FEDERAL ENERGY REGULATORY COMMISSION, Respondent.

Bay State Gas Company, et al., Intervenors.

Nos. 83-1633, 83-1728 and 83-1777.

United States Court of Appeals,

First Circuit.

Argued March 6, 1984.

Decided June 14, 1984.

Harold Hestnes, Boston, Mass., with whom Paul F. Saba, Kim E. Rosenfield, Hale and Dorr, J. Alan MacKay, Boston, Mass., Sherman S. Poland and Ross, Marsh & Foster, Washington, D.C., were on brief, for Distrigas of Mass. Corp. and Distrigas Corp.

L. William Law, Jr., Boston, Mass., with whom Jennifer L. Miller, Boston, Mass., was on brief, for Boston Gas Co.

Michael W. Hall, Gary E. Guy, Cullen & Dykman, John W. Glendening, Jr., and Glendening & Schmid, Washington, D.C., on brief for intervenors, the Brooklyn Union Gas Co. and Bay State Gas Co., et al.

Joshua Z. Rokach, Atty., Washington, D.C., with whom Stephen R. Melton, Acting Gen. Counsel, and Jerome M. Feit, Sol., F.E.R.C., Washington, D.C., were on brief, for respondent.

Before CAMPBELL, Chief Judge, BREYER, Circuit Judge, and GIERBOLINI, ^* District Judge.

BREYER, Circuit Judge.

Distrigas Corporation, a subsidiary of the Cabot Corporation, imports liquefied natural gas (LNG) from Algeria. It sells the LNG to Distrigas of Massachusetts Corp. (DOMAC), another Cabot subsidiary, which pumps it through a terminal, stores it, and resells it to Boston Gas Company and other customers. In September 1976 the Federal Energy Regulatory Commission (then called the Federal Power Commission) determined, contrary to its prior view, that it had authority to regulate DOMAC and Distrigas sales under the Natural Gas Act. 15 U.S.C. Secs. 717 et seq.; see Distrigas Corp. v. Federal Power Commission, 495 F.2d 1057 (D.C.Cir.), cert. denied, 419 U.S. 834, 95 S.Ct. 59, 42 L.Ed.2d 60 (1974).

The Commission did not immediately set rates. Rather, it allowed DOMAC and Distrigas to negotiate rates with their customers, see Distrigas Corp., 58 F.P.C. 2589 (1977), "clarified" in Distrigas Corp., 1 FERC p 61,163 (1977); and it then approved a 'settlement' agreement governing rates between 1978 and 1979, see Distrigas of Massachusetts Corp., 5 FERC p 61,296 (1978), modified, 6 FERC p 61,253 (1979). In 1979, DOMAC (and Distrigas) applied for a rate increase under section 4 of the Natural Gas Act, 15 U.S.C. Sec. 717c. The Commission began to consider whether these proposed rate increases were "just and reasonable." Id. As section 4 provides, the Commission suspended the new rates for several months; they then took effect upon DOMAC's request, subject to refund after a final determination of their 'reasonableness.' (See Appendix for text of section 4.) An ALJ found that major portions of the proposed increase were not justified. And the Commission, for the most part, affirmed that decision. DOMAC and Distrigas now appeal the Commission's decision to us for review. See 15 U.S.C. Sec. 717r(b).

We note that in 1981, while the 1979 proceeding was still pending before the Commission, Distrigas and DOMAC filed for a further rate increase. The interested parties reached a settlement concerning this 1981 increase, conditioning its size on the resolution of several specified issues in dispute in the 1979 proceedings. The Commission has approved this settlement. Distrigas of Massachusetts Corp., 20 FERC p 61,073 (1982). Thus, the rate decision that we here review governs only the period from 1979 to 1981 (which the parties call the "locked-in" period) with the exception of one issue concerning post-1981 refund levels to which we will turn in Part IV.

I

For the most part Distrigas and DOMAC are asking us to set aside certain subsidiary Commission findings--findings that, in part, led the Commission to its final conclusion about what rate was "just and reasonable." We are asked to review these findings under traditional principles of administrative law. We must determine whether the findings of fact are supported by "substantial evidence," 15 U.S.C. Sec. 717r(b); see 5 U.S.C. Sec. 706(2)(E); and we must make certain that the Commission's policy judgments are not "arbitrary, capricious" or an "abuse of discretion." 5 U.S.C. Sec. 706(2)(A). As the Court of Appeals for the District of Columbia Circuit has stated, in a rate case such as this one, applying these standards often comes down simply to insuring

that the Commission's judgment is supported by substantial evidence and that the methodology used in arriving at that judgment is either consistent with past practice or adequately justified ....

City of Batavia v. FERC, 672 F.2d 64, 85 (D.C.Cir.1982) (quoting Public Service Commission v. FERC, 642 F.2d 1335, 1351 (D.C.Cir.1980), cert. denied, 454 U.S. 879, 102 S.Ct. 360, 70 L.Ed.2d 189 (1981)).

The case before us involves the application of classical public utility cost-of-service ratemaking principles. In applying these principles, a regulator traditionally will proceed as follows:

1. He selects a test year (t) for the regulated firm.

2. He adds together that year's operating costs (OC), taxes (T), and depreciation (D).

3. He adds to that sum a reasonable profit determined by multiplying a reasonable rate of return (r) times a rate base (RB). The rate base typically consists of total historical investment minus total prior depreciation. The rate of return typically reflects the coupon rate for long-term debt plus a 'fair' return to shareholder equity.

4. The total equals the firm's revenue requirement (RR). The regulator then allows prices that will equate the firm's gross revenues with this revenue requirement.

These four steps can be reduced to three formulae:

1. RR = OC + T + D + Profit

2. Profit = r(RB)

3. Price = RR/quantity sold

See generally A.E. Kahn, The Economics of Regulation (1970). This general account of ratemaking may help the reader understand to which of these formulae's terms the petitioner's claims and arguments relate and thus how they fit within the larger context of the ratemaking process. We now discuss each challenge in turn.

II

"Extra" Tax Expenditures

During the years 1979-81 (and thereafter) DOMAC will have to pay certain extra taxes (T) because it previously chose to take advantage of specially favorable tax code provisions in the early 1970's, before it became regulated. Its early 1970's tax choices (accelerated depreciation of plant and equipment, expensing instead of capitalizing of certain items) in effect deferred a portion of DOMAC's current tax liabilities into later years. Who should pay these "deferred" taxes? Should they be included as part of the firm's current revenue requirement and passed on to customers in the form of higher rates? Or should they be left out of the revenue requirement, effectively making DOMAC's shareholder (Cabot) pay the extra tax liability out of the ordinary profit that the Commission will allow DOMAC?

The Commission answered these questions here by referring to an approach known as tax "normalization." It treated DOMAC--which first became regulated after obtaining tax benefits--as it would have treated a firm always subject to regulation. It refused to include the extra tax expense in DOMAC's revenue requirement; it required the shareholder to bear the cost; and it also required DOMAC to take an amount equal to the entire "extra" tax payment that it would eventually have to make, subtract it from its rate base, and attribute it to several special accounts representing "Accumulated Deferred Income Taxes." See 18 C.F.R. Part 201, General Instruction 18 and Accounts 281-283. In determining rates, DOMAC, like other utilities, was not entitled to any return on the funds in these special accounts.

DOMAC and Distrigas challenge these decisions. We can best analyze their challenge by taking DOMAC's "accelerated depreciation" liability as a representative example, by explaining how regulatory commissions typically treat this liability, and by then examining DOMAC's argument for different treatment. The conclusions we reach concerning accelerated depreciation apply to the other deferrals here at issue as well.

1. The tax "normalization" problem. The tax normalization problem arises out of Congress's decision to allow firms to Regulators have generally had to decide whether the advantages of this "loan" from the government should accrue to the regulated firm's shareholders or to its customers; they have had to choose between "flow-through" methodologies, which pass the immediate tax benefits on to the ratepayers, and "normalization" methodologies, which preserve more of the immediate tax benefits for the owners. See Federal Power Commission v. Memphis Light, Gas & Water Division, 411 U.S. 458, 465-67, 93 S.Ct. 1723, 1728-29, 36 L.Ed.2d 426 (1973); Public Systems v. FERC, 709 F.2d 73 (D.C.Cir.1983); Memphis Light, Gas & Water Division v. FERC, 707 F.2d 565, 567-69 (D.C.Cir.1983). But see Economic Recovery Tax Act of 1981, Pub.L. No. 97-34, Sec. 201(a), 95 Stat. 172, 203, 208 (codified at 26 U.S.C. Sec. 168(e)(3)) (requiring normalization approach as condition for accelerated depreciation by public utilities of post-1981 properties); 26 U.S.C. Sec. 167(l) (imposing similar condition on use of accelerated depreciation for some post-1969 utility properties).

depreciate plant and capital equipment at a specially fast rate for income tax purposes. See 26 U.S.C. Secs. 167-68. Suppose, for example, a firm buys a piece of equipment for $1 million; it has a twenty-year life. If the firm depreciates the equipment on a "straight line," it will assume a depreciation expense of $50,000 each year for twenty years. Accelerated...