L. S. Ayres & Co. v. Indianapolis Power & Light Co., 871A159

• Citation: 351 N.E.2d 814, 169 Ind.App. 652
• Case Date: July 12, 1976
• Court: Court of Appeals of Indiana

Page 814

351 N.E.2d 814

169 Ind.App. 652

L. S. AYRES & COMPANY et al., Appellants (Intervenors below), v. INDIANAPOLIS POWER & LIGHT COMPANY, Appellee (Petitioner below),

City of Indianapolis, Appellee (Intervenor below),

G. V. Ginger and Associates, Inc., Appellee (Intervenor below),

Watergate Corp., Appellee (Intervenor below),

Simpson-Stygall Co., Inc., et al., Appellees (Intervenors below),

Public Service Commission of Indiana, Appellee,

W. W. Hill et al., Appellees,

Carl E. Van Dorn, Public Counselor of the State of Indiana, Appellee.

No. 871A159.

Court of Appeals of Indiana, Second District.

July 12, 1976.

John J. Dillon, Virginia Dill McCarty, Paul Hirsch, Indianapolis, for appellants

John H. Groves, Alan W. Boyd, Jerry P. Belknap, Shirley A. Shideler and Jon D. Noland of Barnes, Hickam, Pantzer & Boyd, Leslie Duvall, Carl C. Winter, Theodore L. Sendak, Atty. Gen., Ralph W. Husted and Marcus E. Woods, Gary Landau, City Atty., Carl E. Van Dorn, Public Counselor, Paul F. Kortepeter, Indianapolis, for appellees.

STATON, Presiding Judge.

The Indianapolis Power & Light Company, a public utility, filed a petition with the Indiana Public Service Commission to increase its electric rates. A new rate increase would affect 270,454 ratepayers in Boone, Hamilton, Hancock, Hendricks, Johnson, Marion, Morgan, Owen, putnam Before the Commission held a formal hearing upon the petition, G. V. Ginger & Associates, Inc., L. S. Ayres & Company, et al., and the City of Indianapolis filed petitions to intervene which were granted by the Commission.

                and Shelby Counties.  1  The old rates had been in effect since August 1, 1938.  In its petition to increase electric rates, the Petitioner, Indianapolis Power & Light Company, stressed the narrowing margin over past years between its operating revenues and operating expenses.  This narrowing margin had resulted in a denial of a fair return to the Petitioner upon the fair value of its utility properties.  The new rates proposed by the Petitioner would increase operating revenues approximately $14,700,000.00 and would increase income approximately $6,800,000.00 per year
                

After the formal hearing on the petition, the Commission issued an order on July 30, 1971 which granted a rate increase designed to produce an annual operating revenue of $107,460,674.00 on the basis of allowable annual operating expenses of $78,670,994.00. This would result in an annual operating income of $28,789,680.00 to the Petitioner. Intervenor L. S. Ayres & Company is appealing from this order. Our jurisdiction to review the order 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. IC 1971, 8--1--3--1 (Burns Code Ed.).

Our reviewing opinion affirms the Commission's order in part and remands with instruction for further proceedings consistent with our 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. ² 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 to be distributed to the utility's investors. ³ Allowable operating costs include all types of operating expenses (e.g., wages, salaries, fuel, maintenance) plus annual charges for 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 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. ⁴ 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 adjustment to test-year data is usually referred to as an 'out-of-period adjustment.'

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. ⁵ 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. ⁶ 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. ⁷ 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 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 compared with the utility's existing rate of return, and thus serves as an initial point 'What annual rate will constitute just compensation depends upon many circumstances, and must be determined by the exercise of a fair and enlighted 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.'

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...