Millinocket Water Co. v. Maine Public Utilities Com'n

• Decision Date: 30 September 1986
• Citation: 515 A.2d 749
• Parties: MILLINOCKET WATER COMPANY v. MAINE PUBLIC UTILITIES COMMISSION, et al.
• Court: Maine Supreme Court

Page 749

515 A.2d 749

MILLINOCKET WATER COMPANY v. MAINE PUBLIC UTILITIES COMMISSION, et al.

Supreme Judicial Court of Maine.

Argued May 7, 1986.

Decided Sept. 30, 1986.

Verrill & Dana, Roger Putnam (orally), Richard N. Bryant, Portland, for Millinocket Water Co.

Drummond, Woodsum, Plimpton & MacMahon, P.A., Thomas H. Allen, Portland, for amicus curiae Maine Water Co.

Morgan, Lewis & Bockius, Alan L. Reed, Philadelphia, Pa., for amicus curiae Nat. Ass'n of Water Companies.

Dale L. Gavin (orally), Joseph Donahue, for Maine Public Utilities Com'n, Augusta.

Clifford, Clifford & Stone, Alan G. Stone (orally), Lewiston, for Town of Millinocket.

Paul A. Fritzsche, Public Advocate, Augusta.

Before NICHOLS, ROBERTS, WATHEN, GLASSMAN and SCOLNIK, JJ.

ROBERTS, Justice.

On December 26, 1984 Millinocket Water Company (Company) filed a request with the Public Utilities Commission pursuant to 35 M.R.S.A. § 64 (Supp.1985) to increase the rates of its customers. The proposed rates were designed to produce a net increase in annual operating revenues equal to 34.8% or $153,500.

Following several days of public hearings, the Commission by order dated September 26, 1985 denied all of the Company's request except $27,197 and authorized a revised schedule of rates. ¹ In its order the Commission also denied the Company its requested rate case expenses in excess of $100,000 by awarding the test-year expense of $5,889 as a normal annual rate case expense. The Company sought timely review of the Commission's order by filing both an appeal pursuant to 35 M.R.S.A. § 303 (1978) and a complaint under the authority of 35 M.R.S.A. § 305 (1978). Before us, the Company contends that the Commission erred in determining its cost of equity and in awarding only $5,889 in annual rate case expenses. For the reasons set forth below, we affirm the Commission's order and supplemental order in all respects and enter judgment for the defendant on the Section 305 complaint.

I. Cost of Equity

In calculating cost of equity in this case the Commission employed the following methodology. In light of the fact that the Company is a wholly owned subsidiary of General Waterworks Corporation (GWC) the Commission, at the suggestion of the Company's cost of capital expert, used GWC as a proxy to determine the Company's cost of capital. ² Because GWC, in turn, is wholly owned in equal shares by I.U. International Corporation and Lyonnaise American Holding, Inc., the Commission also accepted the expert's suggestion that GWC be compared to other utilities whose stock is publicly traded in order to employ the discounted cash flow method to determine cost of equity.

In its analysis, however, the Commission found the other utilities chosen by the Company's expert to be incomparable to GWC because his sample did not include utilities that earned a sizeable portion of their income from the sale of utility property. GWC, the Commission found, derived an annual average of 32.5% of its earnings from the sale of utility property over the 1978-1984 period. According to the Commission this pattern of deriving gains from non-utility operations reduced the risk inhering in equity ownership and lowered GWC's cost of equity. ³

In order to take account of these sales, the Commission made an adjustment to the calculation of cost of equity for the sample group chosen by the Company's expert. After computing the sample's cost of equity to be 12% on the basis of a discounted cash flow analysis, the Commission reduced this figure by 32.5%, GWC's average gain from the sale of utility property, and arrived at a cost of equity of 8.1%.

On appeal, the Company argues that the Commission's 32.5% adjustment to the sample's cost of equity deprived it of a reasonable rate of return in violation of the United States and Maine Constitutions. It is the Company's position that through this adjustment the Commission indirectly worked a "flow-through" of gains, achieved by other geographically distinct subsidiaries owned by GWC, to Millinocket ratepayers, a practice prohibited in Maine Water Co. v. Public Util. Comm'n, 482 A.2d 443 (Me.1984).

In reviewing the propriety of the method used for setting rate of return in this case, we begin by acknowledging that this Court traditionally defers to the Commission's expert judgment in choosing among various ratemaking techniques or methodologies. We will uphold the Commission's decision if the choice of method is reasonable and supported by substantial evidence. New England Tel. & Tel. Co. v. Public Util. Comm'n, 448 A.2d 272, 279 (Me.1982). New England Tel. & Tel. Co. v. Public Util. Comm'n, 470 A.2d 772, 776 (Me.1984). This deferential standard grows out of the understanding that

Determining the cost of equity is one of the more difficult computations in the rate-making process. The Commission must concern itself with many economic variables and evaluate conflicting evidence interpreting and applying those variables.

New England Tel. & Tel. Co. v. Public Util. Comm'n, 448 A.2d at 287-88. We do not attempt to second-guess the Commission on matters falling within its realm of expertise. Cost of equity is one of the calculations that the Commission must make in order to determine a fair rate of return for the utility. Central Maine Power Co. v. Public Util. Comm'n, 455 A.2d 34, 38 (Me.1983). It represents what a utility must pay in order to attract financing from equity investors for its common or preferred stock, New England Tel. & Tel. Co. v. Public Util. Comm'n, 390 A.2d 8, 32 (Me.1978), and, as such, is the figure necessary to compensate investors for the risk assumed. Federal Power Comm'n. v. Hope Natural Gas Co., 320 U.S. 591, 605, 64 S.Ct. 281, 289, 88 L.Ed. 333 (1944).

In Mars Hill & Blaine Water Co. v. Public Util. Comm'n, 397 A.2d 570, 585-87 (Me.1979), we approved use of the consolidated capital structure of the parent corporation for determining cost of equity when the utility being regulated is a wholly owned subsidiary without capital costs of its own. Under such a methodology, market evaluation of the parent's stock is thought to afford the primary evidence of the current cost of equity to the subsidiary. Phillips, The Regulation of Public Utilities, p. 352 (1984). Use of this approach allows the Commission to assume that the cost of the parent's common equity is the same as that of the utility being regulated. See Legislative Util. Consumers' Council v. Granite State Electric Co., 119 N.H. 359, 402 A.2d 644, 648 (1979); Ohio Suburban Water Co. v. Public Util. Comm'n, 62 Ohio St.2d 17, 20; 402 N.E.2d 539, 541 (1980). Thus, the parent becomes the direct proxy for the subsidiary and the Commission's calculations are directed at measuring the parent's costs.

Consistent with the above authorities, the Commission in this case employed the consolidated capital structure of the Company's parent, GWC, to determine the cost of equity of Millinocket Water Company. Because GWC is also a wholly owned corporation without public stock to be evaluated, it was necessary to employ a comparable earnings approach to measure GWC's cost of equity by calculating the cost of equity for a sample of other similar utilities. The comparable earnings approach "is implemented by examining earnings on book common equity for enterprises that have comparable risks ..." Phillips at 361.

In applying the comparable earnings standard in this case, however, the Commission found that the Company's expert failed to examine utilities with similar risks to GWC because he eliminated from consideration all utilities that earn a substantial portion of their profits from the sale of utility property. In order to correct the expert's calculation and to reflect better the risk of investment in GWC, as proxy for the Company, the Commission simply determined the cost of equity of the sample group (12%) and then reduced this figure by 32.5%, the percentage of profit earned annually by GWC from the sale of utility property, to arrive at a figure of 8.1% as representative of GWC's, and thus the Company's cost of equity. Inasmuch as the methodology applied by the Commission reasonably reflects the risk inherent in investing in GWC, and because GWC was the appropriate corporate level at which the Commission could direct its analysis, we affirm the Commission's decision on cost of equity as reasonable and supported by substantial evidence.

The Commission's use of the above approach, moreover, does not violate the holding of Maine Water Co. v. Public Util. Comm'n, 482 A.2d 443 (Me.1984). In that case we struck down an attempt by the Commission to effect a dollar-for-dollar "flowthrough" of gains realized by Maine Water Company in selling its Newport & Wilton...