Mystic Valley Gas Co. v. Department of Public Utilities

• Decision Date: 03 May 1971
• Citation: 359 Mass. 420,269 N.E.2d 233
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court
• Parties: , 90 P.U.R.3d 131 MYSTIC VALLEY GAS COMPANY v. DEPARTMENT OF PUBLIC UTILITIES (and two companion cases).

Page 233

269 N.E.2d 233

359 Mass. 420, 90 P.U.R.3d 131

MYSTIC VALLEY GAS COMPANY v. DEPARTMENT OF PUBLIC UTILITIES (and two companion cases).

Supreme Judicial Court of Massachusetts, Suffolk.

Argued April 6, 1971.

Decided May 3, 1971.

Lane McGovern, Boston, (Donald W. Glazer, Boston, with him), for petitioner.

Charles K. Mone, Asst. Atty. Gen. (Walter H. Mayo, III, Asst. Atty. Gen., with him), for Dept. of Public Utilities.

Before TAURO, C.J., and CUTTER, REARDON, QUIRICO and BRAUCHER, JJ.

CUTTER, Justice.

These three appeals seek review (G.L. c. 25, § 5, as amended through St.1956, c. 190) of orders of the department (D.P.U.) entered on November 28, 1969, in rate proceedings brought by Mystic Valley Gas Company (Mystic), North Shore Gas Company (North Shore), and Lynn Gas Company (Lynn). Each company ¹ has appealed separately from the order affecting it. A single justice reserved and reported each case for the decision of the full court upon the evidence before the D.P.U.

GENERAL BACKGROUND.

Each company 'was part of * * * New England Electric System (N.E.E.S.) The proceedings before the D.P.U. are summarized in the margin. ³ As to each of the petitioners, the D.P.U. allowed only a minor portion of the increased rates requested. ⁴ The cases, heard together before the D.P.U., were argued together before this court.

which includes, in addition to * * * eight gas companies, Massachusetts Electric Company, narragansett Electric Company, and New England Power Company, as well as the parent company' (N.E.E.S.). The D.P.U. in its decisions states 'Although there is a small minority (common stock) interest in some' of the N.E.E.S. constituent gas operating companies, 'for all practical purposes there is no market for * * * (their) stock * * * almost all of which is held by' N.E.E.S. That system however, is a party to 'divestment' proceedings before the Securities and Exchange Commission (S.E.C.) which may result in the reasonably near future in the relinquishment by N.E.E.S. of its share-holdings in operating gas companies. ²

THE ISSUES IN GENERAL

Each company seeking review raises several substantially similar issues, which in large measure can be discussed together for all three companies. The action of the D.P.U. concerning Lynn requires some separate discussion (see part 4 of this opinion, infra). The issues as to each company relate (a) to the appropriate capital structure and the cost of certain capital and (b) to the D.P.U.'s failure to adjust test year results to reflect known future increases in the costs of service. ⁵ In the first instance, we discuss the issues as they apply to Mastic (and with substantially equal force to North Shore). We then mention the few significant different aspects of Lynn's situation as compared with that of each of the other two companies.

GENERAL PRINCIPLES

1. The petitioners contend that the rates set for each of them are confiscatory. It thus is our duty to afford these utilities 'an

independent judicial review as to both law and fact.' See Opinion of the Justices, 328 Mass. 679, 686-690, 106 N.E.2d 259; New England Tel. & Tel. Co. v. Department of Pub. Util., 327 Mass. 81, 85, 97 N.E.2d 509; Wannacomet Water Co. v. Department of Pub. Util., 346 Mass. 453, 457, 194 N.E.2d 109; BOSTON GAS CO. V. DEPARTMENT OF PUB. UTIL., MASS., 269 N.E.2D 248.^A See also G.L. c. 30A, § 14(8)(f); Salisbury Water Supply Co. v. Department of Pub. Util., 344 Mass. 716, 717-718, 184 N.E.2d 44. Each petitioner is entitled to 'enough revenue not only for operating expenses but also for the capital costs of the business,' including 'service on the debt and dividends on the stock.' The return should be 'sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital.' See Federal Power Commn. v. Hope Natural Gas Co., 320 U.S. 591, 603, 64 S.Ct. 281, 88 L.E.2d 333.

CAPITAL STRUCTURE AND RATE OF RETURN.

2. Mystic, as of December 31, 1968, the end of the test year, had a capital structure of 61.8% debt and 38.2% common stock. ⁶ The debt and capital stock outstanding consisted of

                First Mortgage Bonds
                --------------------
                   Ser.  A--3 5/8% due 1974               $5,500,000
                        (issued 1954)
                   Ser.  B--6% due 1977                    3,500,000
                        (issued 1957)
                Notes Payable (unsecured)
                -------------
                   Due March 31, 1969 @ 6 3/4%           10,625,000
                       (issued 12-26-68 and 12-30-68)
                Capital Stock
                -------------
                   379,385 common shares ($25 par val.)   9,484,625 7
                

Mystic has 'no plans to issue (additional) mortgage debt in the immediate future.' In 1969, Mystic's unsecured debt was expected to remain about $10,000,000 and to carry the 'prime rate' of interest plus some additional cost because of lender bank requirements that borrowers carry 'compensating balances' on deposit. ⁸ For a number of years, contrary to 'typical' utility practice, Mystic has obtained additional debt financing by short term borrowing at or near the prime rate. Among reasons mentioned for this practice were (a) the pendency of the S.E.C. divestment proceedings (fn. 2, supra), which made long-term commitments somewhat undesirable; (b) the advantages of 'financing * * * at the prime rate, which * * * was below the (contemporaneous) long-term debt rate * * * through' the 1960's; (c) the disadvantages of 'spending an undue amount in the expenses of selling * * * small (bond) issues'; (d) the circumstance that these companies (at least until their divestment by N.E.E.S.) would be 'under the umbrella of a large holding company' with the consequence that the method employed 'has been an economical way to finance' while 'going through a period of uncertainty' about divestment. ⁹

Ladd, called by the petitioners, expressed the view that Mystic should 'be evaluated as an independent company that would be viable and financially sound even without' the protection of the parent company, N.E.E.S. He expressed the view that 'this * * * would be appropriate even without' the S.E.C. order that N.E.E.S. divest itself of its gas properties. He accordingly used Mystic's existing capital structure in determining what the cost of Mystic's debt capital should be. ¹⁰

David A. Kosh (a public utility consultant called by the D.P.U.) was of the opinion "that the appropriate embedded cost of debt for * * * (the N.E.E.S. gas subsidiaries) is the present cost of outstanding debt of the (s)ystem, and not the actual costs of debt of the individual companies." ¹¹ He concluded 'it would be unreasonable to use the actual capital structure of each of these entities to determine the fair rate of return for each.' He suggested 'two alternative * * * capital structures' viz. (a) 'the actual combined capital structure of the gas subsidiaries of N.E.E.S. after reflecting the extent to which the parent has financed their equity * * * by selling debt,' or (b) 'the actual capital structure of the system consolidated.' The latter he computed to be 60% debt, 9% preferred stock, and 31% equity.

The D.P.U. adopted (as the suitable capital structure for Mystic) essentially the second of the alternative solutions suggested by Kosh. In its decision it said, in part, '(T)he issue is not whether the (s)ystem costs are in fact the cost of the subsidiary, nor whether the separate corporate identity of each subsidiary can be ignored * * *. Rather, we * * * decide what would be fair capital structure with which to charge the rate-payers * * *. Thus, recognizing the separate corporate identity of the companies in * * * (N.E.E.S.), they have been financed on a system basis, and * * * little attention has been paid on an individual company basis to the matter of arriving at a 'fair' capital structure.' ¹² The D.P.U. concluded (a) that it was 'reasonable to use as a guide the (s)ystem capitalization which reflects the average situation that the gas companies as a group would enjoy today if they had been financed in part by permanent securities over a representative period'; (b) 'that a common equity ratio of forty percent * * * (was) too high for' Mystic, and (c) that 'a capitalization of sixty percent debt, nine percent preferred, and thirty-one percent equity * * * (would) be fair for this Company.' Accordingly, the D.P.U. fixed as the cost of Mystic's debt a return of 5.2% which was the then 'average cost of (s)ystem debt, adjusted to reflect' $20,000,000 of new system debt to be incurred at current 1968-1969 costs. It took as the cost of Mystic's assumed preferred stock 5.35%, the cost of a relatively recent issue of preferred stock of a constituent N.E.E.S. company, and adopted a return of 10.75% as the proper return upon the 31% common stock equity assumed by the D.P.U. for Mystic. As the composite rate of return on Mystic's rate base, the D.P.U. allowed 7.1%. Mystic does not now object, as already noted (fn. 5), to the rate base adopted by the D.P.U. or to its determination of 'the appropriate cost rate for common equity.' Mystic, however, does press its contention that the D.P.U., erroneously and without justification, attributed to it a hypothetical capital structure (see fn. 5, supra) and, as a consequence, gave it an inadequate return.

The D.P.U. relies in part on statements in two earlier decisions for support of its decision to substitute for Mystic's actual capital structure a hypothetical capital structure based on that of N.E.E.S. as a system. In New England Tel. & Tel. Co. v. Department of Pub. Util., 327 Mass. 81, 87, 91--92, 97 N.E.2d 509, 514 (the 1951 telephone case), the company desired to reduce its then 'top heavy' debt ratio 'all at once' to 35%. The department thought 'that a reduction to 45% would be safe.' The company contended that debt ratio was 'a matter for the exclusive determination of the (company's) management.' In commenting on this contention, the opinion said (emphasis supplied), '(A) public regulatory board cannot assume the management of the company...