Gas v. Dep't of Pub. Utilities.

• Decision Date: 02 November 2011
• Docket Number: SJC–10855.
• Citation: 956 N.E.2d 213,460 Mass. 800
• Parties: FITCHBURG GAS AND ELECTRIC LIGHT COMPANY 1v.DEPARTMENT OF PUBLIC UTILITIES.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

460 Mass. 800

956 N.E.2d 213

FITCHBURG GAS AND ELECTRIC LIGHT COMPANY 1

v.DEPARTMENT OF PUBLIC UTILITIES.

SJC–10855.

Supreme Judicial Court of Massachusetts, Suffolk.

Argued Sept. 7, 2011.Decided Nov. 2, 2011.

Robert J. Keegan (Cheryl M. Kimball with him), Boston, for the plaintiff.David A. Guberman, Assistant Attorney General, for the defendant.Present: IRELAND, C.J., SPINA, CORDY, BOTSFORD, GANTS, DUFFLY, & LENK, JJ.

CORDY, J.

Fitchburg Gas and Electric Light Company (Fitchburg or company) appeals from a ruling of the Department of Public Utilities (department) ² requiring it to reimburse its customers over $4.6 million in gas supply costs incurred during the 2007–2008 and 2008–2009 purchasing seasons. In its ruling, the department determined that Fitchburg had failed to seek preapproval of its gas purchasing plans for those years as it had been required to do, because the plans were intended to stabilize gas supply prices through the use of forward contracts.³ The department separately found that Fitchburg acted imprudently when executing its gas purchasing plans. An appeal was filed with a single justice of this court, pursuant to G.L. c. 25, § 5, and was reserved and reported, without decision, to the full court.

We conclude that the department's determination that Fitchburg's purchasing plans required preapproval was erroneous, as the plans incorporated only traditional risk management techniques that had previously never been subject to the department's preapproval. Penalizing Fitchburg for failing to seek preapproval, when such preapproval was never required, exceeds the department's authority and amounts to an error of law. With respect to the allegedly imprudent purchases, we agree with the department that one of the purchases at issue, made in November, 2008, was unreasonable and imprudent, but hold that the department's findings of imprudence with regard to the balance of the purchases in 2007 and 2008 were not supported by substantial evidence.

1. Regulatory background. The department supervises rate setting by natural gas local distribution companies (LDCs). G.L. c. 164, § 94. The department reviews gas procurement contracts and rate setting consistent with the legislative policy “to provide a reliable energy supply for the commonwealth with a minimum impact on the environment at the lowest possible cost.” G.L. c. 164, § 69H.

A natural gas bill consists of two components: a supply cost and a distribution cost. Bay State Gas Co., D.T.E. 01–09 at 3 (2001). The supply cost refers to the expense involved in purchasing and transporting gas on the interstate pipeline to Massachusetts. Id. Distribution costs refer to an LDC's operating costs for bringing gas from the interstate pipeline to a customer's meter. Id. The present case concerns only supply costs.

Supply costs are recovered from customers on a dollar-for-dollar basis, through a reconciliation mechanism known as the cost of gas adjustment clause (CGAC). Id. That is, LDCs do not profit from the supply portion of a gas bill, and the cost of purchasing gas is a straight pass-through to the customer. Id. See 220 Code Mass. Regs. § 6.00 (2008). The rate that LDCs bill customers for gas supply is called the gas adjustment factor (GAF). 220 Code Mass. Regs. § 6.06. LDCs recalculate GAFs on a semiannual basis, once for the peak season of November 1 to April 30 and once for the off-peak period of May 1 to October 31. See 220 Code Mass. Regs. § 6.11. In addition, LDCs are required to submit revised GAFs any time their deferred gas-cost balances at the end of a period are projected to be greater or less than five per cent of the total seasonal gas costs stated in their effective GAF. Investigation Concerning the Cost of Gas Adjustment Clause, D.T.E. 01–49–A at 8 (2001).

For supply costs to be recovered, the expenditures must have been reasonably and prudently incurred. G.L. c. 164 § 94G. “It is well-settled that while public utilities should be permitted to charge rates which are compensatory of the full cost incurred by efficient management, they may not recover costs which are excessive, unwarranted, or incurred in bad faith.” Boston Gas Co. v. Department of Pub. Utils., 387 Mass. 531, 539, 441 N.E.2d 746 (1982), and cases cited. When conducting a prudence review, the department determines whether a utility's actions, based on all that it knew or should have known at the time, were reasonable and prudent in light of the circumstances which then existed. Hingham v. Department of Telecomm. & Energy, 433 Mass. 198, 202, 740 N.E.2d 984 (2001). Such a determination may not be made on the basis of hindsight judgments, nor is it appropriate for the department merely to substitute its own judgment for the judgments made by the management of the utility. Attorney Gen. v. Department of Pub. Utils., 390 Mass. 208, 229, 455 N.E.2d 414 (1983).

The present case concerns risk management techniques used in the procurement of natural gas. During the 1980's and 1990's, the price of natural gas remained essentially stable, at between two dollars and $2.50 per Dekatherm (DTh).⁴ Bay State Gas Co., D.T.E. 01–09 at Executive Summary (2001). LDCs would purchase approximately one-third of their winter needs during the off-peak season, and would store the gas in underground reservoirs. The balance of the purchasing would take place during the peak winter season, using either “first of the month” or “spot” (i.e., daily) pricing.

The winter of 2000–2001 was the coldest nationwide in the 105 years of United States Weather Bureau records. After fifteen years of essentially stable prices, the price of gas nearly quintupled. Bay State Gas Co., D.T.E. 01–09, supra. This sharp increase was passed directly to consumers through the CGAC. Both LDCs and the department recognized the desirability of shielding consumers from such dramatic price fluctuations. Id. at 10–11.

In December, 2001, the department opened an investigation concerning the use of risk management techniques to mitigate gas price volatility. Investigation of Risk–Management Techniques, D.T.E. 01–100–A (2002) (Order). The investigation considered, in pertinent part, whether LDCs should be allowed or required to implement a risk management program, and what standard of review the department should use when reviewing a proposed program. Id. at 1–2.

The department issued its findings in the October, 2002, Order. Order, supra. The Order permitted risk management programs that incorporated financial derivatives,⁵ subject to certain conditions. See Order, supra at 3–8.

The Order evaluated numerous concerns relating to the use of financial derivatives to manage risk and stabilize the price of gas. At the outset, the Order highlighted the distinction between derivatives trading and traditional forms of risk management, including forward contracting:

“A distinction should be made regarding traditional forms of risk-management, which include the use of storage to offset winter demand, through the use of physical gas purchases and forward contracts, and modern risk-management functions, which use financial futures and option contracts to effectuate various forward pricing strategies. For purposes of this Order, both ‘risk-management’ and ‘hedging’ are used interchangeably to mean the use of financial derivative products in combination with physical gas purchases to mitigate commodity price volatility ” (emphasis added). (Footnotes omitted.)

Order, supra at 2. The Order then explained why derivatives could be risky. Purchasing derivatives can be costly; and, while the use of derivatives may dampen volatility, it is unlikely to produce prices below index levels averaged over time. See Order, supra at 5–6. Additionally, LDCs that attempt to “beat the market” may engage in speculative purchases that result in over-all higher risk. Id. at 6. Further, overhead expenditures, such as professional staffing, information technology, and consulting, may render the use of financial derivatives prohibitive, especially for small companies. Id.

Nevertheless, the department refused to bar categorically risk management plans that use financial derivatives, finding that the risks of such plans “can appropriately be reviewed on a case-specific basis, and in unison with an LDC's supply design, size, and position in the market, before any determination could be made as to whether the risks are too high.” Order, supra at 7. Therefore, the department concluded that it would “allow, but not require, Massachusetts LDCs to use financial risk-management instruments to mitigate commodity price volatility,” and would “review and approve LDC risk-management proposals on a case-specific basis.” Id. at 8. At the end of the Order, the department set out the standard of review for such risk management plans.⁶

Between 2002 and 2009, three LDCs sought preapproval of risk management plans. Only one of the plans specifically incorporated financial risk management instruments. In each case, the department applied the standard elucidated in the Order but failed to clarify whether the Order had mandated the companies to seek preapproval.

On August 25, 2003, KeySpan Energy Delivery New England (KeySpan) ⁷ sought approval of a risk management plan. KeySpan, D.T.E. 03–85 (2003). KeySpan had already been purchasing approximately thirty-two per cent of its winter gas requirements during the preceding spring and summer months, storing the gas in underground storage facilities or in liquefied natural gas tanks. Id. KeySpan proposed to “lock in” the price of an additional quantity of gas through the use of forward contracts, so that the price would be locked in for approximately two-thirds of KeySpan's winter requirements. KeySpan would lock in prices for equal quantities of gas, once a month, over the twelve months preceding a given winter.⁸ Id. at 1–2. KeySpan did not propose to use financial derivatives.⁹ Id. at 4 n. 1.

The department applied the...