Hope Natural Gas Co. v. Federal Power Commission, 4979.

• Decision Date: 17 May 1943
• Docket Number: No. 4979.,4979.
• Citation: 134 F.2d 287
• Parties: HOPE NATURAL GAS CO. v. FEDERAL POWER COMMISSION et al.
• Court: U.S. Court of Appeals — Fourth Circuit

134 F.2d 287 (1943)

HOPE NATURAL GAS CO. v. FEDERAL POWER COMMISSION et al.

No. 4979.

Circuit Court of Appeals, Fourth Circuit.

February 16, 1943.

Writ of Certiorari Granted May 17, 1943.

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William B. Cockley, of Cleveland, Ohio (Walter J. Milde, Theodore R. Colborn, and William A. Dougherty, all of Cleveland, Ohio, and Kemble White and Anthony F. McCue, both of Clarksburg, W. Va., on the brief), for petitioner.

Milford Springer, for Federal Power Commission, of Washington, D. C., and Spencer W. Reeder, Asst. Director of Law in Charge of Utility Controversies for City of Cleveland, of Cleveland, Ohio (Charles V. Shannon, Louis W. McKernan, and Howell Purdue, all of Washington, D. C., of counsel for Federal Power Commission; Thomas A. Burke, Jr., Director of Law, of Cleveland, Ohio, for City of Cleveland; Robert E. May, of Washington, D. C., and Alexander W. Parker and Joseph M. Winston, Jr., both of Richmond, Va., Attys. for City of Cleveland; A. F. O'Neil, Director of Law, and Clyde B. Macdonald, Asst. Director of Law, both of Akron, Ohio, for City of Akron, Attys. for City of Akron; Claude T. Reno, Atty. Gen. of Pennsylvania, and Harry M. Showalter, Counsel, and Samuel Graff Miller, Asst. Counsel, both of Harrisburg, Pa. for Pennsylvania Public Utility Commission, on the brief), for respondents.

Before PARKER, SOPER, and DOBIE, Circuit Judges.

Writ of Certiorari Granted May 17, 1943. See 63 S.Ct. 1165, 87 L.Ed. ___.

PARKER, Circuit Judge.

This is a petition by the Hope Natural Gas Company, hereafter referred to as "Hope", to review an order of the Federal Power Commission under the provisions of § 19(b) of the Natural Gas Act of June 21, 1938, 52 Stat. 831, 15 U.S.C.A. § 717r (b). Hope, a subsidiary corporation of the Standard Oil Company of New Jersey, was organized under the laws of West Virginia in the year 1898 and since that time has been engaged in the production, transportation and sale of natural gas. 80% of its sales are in interstate commerce and are subject to the jurisdiction of the Commission, but its interstate rates had not been regulated prior to this proceeding. In 1938 the cities of Cleveland and Akron, Ohio, filed complaints with the Commission alleging that the rates charged by Hope to the East Ohio Gas Company were unreasonable. The Pennsylvania Public Utility Commission filed complaints that the rates charged to the Peoples Natural Gas Company, the Fayette County Gas Company and the Manufacturers Light and Heat Company were also unreasonable. The Commission then instituted an investigation, on its own motion, into the reasonableness of all of Hope's interstate wholesale rates; and all of the proceedings relating to these rates were consolidated for hearing before the Commission.

On May 26, 1942, the Commission filed its opinion, findings and order holding that the rates charged since June 30, 1939 were unreasonable and establishing reduced rates for the future, the reduction ordered being approximately 20% in the rates charged the East Ohio Gas Company and the Peoples Natural Gas Company, both Standard Oil affiliates, to which by far the larger part of its sales were made. The rates to these companies were reduced from 36.5 and 35.5 cts. per m. c. f. to 29.5 and 28.5 cts. per m. c. f. respectively. Rates to two other companies, Fayette and Manufacturers, representing a small volume of the total sales, were reduced from 31.5 cts. to 28.5 cts.

The reductions in rates were ordered on the basis of findings made as to the value of Hope's property used in connection with its interstate business, the estimated operating expenses of the business and a rate of return upon investment of 6?%. Hope complains of the findings with respect to all of these matters but particularly with respect to the valuation of the property adopted as the rate base. The valuation adopted by the Commission as the rate base was arrived at by taking the cost of the property as shown by the books of the company, corrected for bookkeeping errors but without allowance for price increases or consideration of capital items theretofore charged to expense, and deducting therefrom accrued depreciation based upon the estimated useful life of the property employed without reference to evidence as to its present condition based upon tests and observation. This method was applied to property taken over from other companies as well as to property originally purchased by Hope. The corrected book cost of the property was found to be $51,957,416, and depreciation was found to be $22,328,016 as of December 31, 1940, leaving a net investment of $29,629,400. To this was added $1,392,021 for net capital additions up until the effective date of the order, $566,105 for useful unoperated acreage and $2,125,000 for working capital. This gave a rate base of $33,712,526.

Hope introduced evidence to the effect that prior to 1923 labor costs in well drilling as well as the portion of the overhead expense of the company allocable thereto had been treated as expense in its bookkeeping entries, instead of being charged to capital account; that these items were a legitimate part of the cost of the property and present expenditures of like character were required to be so treated in the system of accounting prescribed by the Commission; that the items representing such expenditures prior to 1923 should be considered by the Commission as a part of the legitimate cost of the property notwithstanding they had been charged to expense; and that, when they were so considered, the cost of the property was shown to be $69,735,000, instead of $51,957,416.

It was shown that the property used by Hope in its interstate business had been constructed over a forty year period during which there had been great fluctuations in prices and that prices at the time of hearing were at a far higher level than they were during the years preceding the first world war. The Public Utilities Commission of Ohio had found the reproduction cost new of the property, as of June 30, 1937, to be $100,257,000 and its present value after depreciation to be $66,166,382.¹ Hope introduced an estimate of cost of reproduction new amounting to $97,340,000 and a statement showing that the application of price trends to original cost would result in a figure of $105,101,000. This price trend statement showed that for property placed in public service between 1891 and 1916 at an original cost of $25,249,550 the price trends gave a figure of $52,451,675, whereas for property placed in service between 1917 and 1938 at a cost of $45,303,889 the trended value was only $53,788,551. Hope contended that the allowance for depreciation should have been based on the actual condition of the property as determined by observation with allowance for obsolescence; and that the depreciation allowance resulting was 34.51%. Applying this rate of depreciation to the estimate of the cost of reproduction new of its property, it arrived at a rate base as of December 31, 1938, of $66,360,000.

The Commission found that Hope's estimates of reproduction cost and trended original cost were without probative value and disregarded them, as it did also Hope's evidence as to the observed condition of the property. No consideration was given to the change in price levels which was shown by the estimates and which, even in their absence, might have been noticed as matters of general and common knowledge.

The vital questions in the case relate to the determination of the rate base; and, in view of the low rate of return allowed and the consequent lack of margin to take care of error in the base, the rates allowed must be condemned as unreasonable and confiscatory because of the following errors with respect to the valuation of the property constituting the base: (1) the Commission did not find the present fair value of the property and took no account of the change of price levels in determining the rate base; (2) the Commission ignored items of well drilling costs and overhead, aggregating in excess of $17,000,000, which entered into the original cost of the property, basing this action on the fact that, under the system of accounting that prevailed at the time, these items had been charged on the company's books to expense; and (3) the Commission ignored evidence as to the present condition of the property and computed accrued depreciation theoretically on the straight-line service-life method. We shall discuss these matters separately in the order named.

Present Value.

The report of the Commission shows, not only that it gave no consideration to rise in price levels in determining the amount of the rate base, but also that it made no attempt to ascertain the present fair value of the property involved. It adopted as the rate base the original cost of the property as shown by the company's books, adjusted to correct bookkeeping errors and depreciated as above indicated. It took the view that this depreciated book cost could properly be taken as the base without reference to whether it did or did not represent the present fair value of the property saying: "With the decline in favor of `fair value' as the only mode of public utility rate regulation, its keystone, reproduction cost, crumbles. Bona fide investment figures now become all important in the regulation of rates".

Much is to be said in favor of the prudent investment theory of determining the rate base. It is simple; it is expeditious; and it avoids the necessity of resorting to unsatisfactory estimates of the cost of reconstructing a system that no one would now reconstruct. Where there has been no great change in price levels, prudent investment cost can be taken, subject to appropriate depreciation, as representing the present fair value of the property for rate making purposes. And even where there have been changes in price levels, it can be thus taken, we think, if...