Sekan Elec. Co-op. Ass'n, Inc. v. State Corp. Commission, 51292

• Decision Date: 21 March 1980
• Docket Number: No. 51292,51292
• Citation: 4 Kan.App.2d 477,609 P.2d 188
• Parties: The SEKAN ELECTRIC COOPERATIVE ASSOCIATION, INC., Applicant, v. STATE CORPORATION COMMISSION of the State of Kansas, Richard C. Loux, Chairman, William S. Gray, Commissioner, Respondent.
• Court: Kansas Court of Appeals

Page 188

609 P.2d 188

4 Kan.App.2d 477

The SEKAN ELECTRIC COOPERATIVE ASSOCIATION, INC., Applicant, v. STATE CORPORATION COMMISSION of the State of Kansas, Richard

C. Loux, Chairman, William S. Gray, Commissioner,

Respondent.

No. 51292.

Court of Appeals of Kansas.

March 21, 1980.

Syllabus by the Court

On judicial review of an order of the Kansas Corporation Commission in a utility rate case it is held :

1. The order did not exclude part of the utility's equity capital from its rate base.

2. A utility's rate of return need not be large enough to repay long term debt.

3. The Commission was justified in rejecting the utility's proposed declining block rate schedule and in ordering a schedule with a fixed customer or minimum charge, augmented by a flat per kilowatt hour energy charge.

James M. Caplinger of James M. Caplinger, Chartered, Topeka, for applicant.

Curtis M. Irby, Asst. Gen. Counsel, Kansas Corp. Commission, Wichita, for respondent.

Before FOTH, C. J., and ABBOTT and PARKS, JJ.

FOTH, Chief Judge:

The Sekan Electric Cooperative Association, Inc., is a nonprofit corporation engaged in the distribution of electricity to some 3900 member-customers in southeast Kansas. In November, 1978, it filed an application with the Kansas Corporation Commission for a rate increase to produce an additional $248,379 in operating revenues. The Commission fixed a rate of return which would produce only an additional $18,751. Sekan has sought judicial review, contending that the Commission's order (1) excluded a portion of its equity capital from its rate base; (2) improperly prevents it from recovering its capital costs; and (3) arbitrarily rejected its proposed rate structure.

In examining these contentions we must bear in mind the limitations on our scope of review, recently recapitulated in Midwest Gas Users Ass'n v. Kansas Corporation Commission, 3 Kan.App.2d 376, 380-81, 595 P.2d 735, 738-739, rev. denied 226 Kan. VIII (September 11, 1979):

"K.S.A.1978 Supp. 66-118d limits judicial review of an order by the commission to determining whether the order is 'lawful' or 'reasonable.' Kansas Gas & Electric Co. v. State Corporation Commission, 218 Kan. 670, Syl. P 1, 544 P.2d 1396 (1976). A court has no power to set aside such an order unless it finds that the commission acted unlawfully or unreasonably. Jones v. Kansas Gas and Electric Co., 222 Kan. 390, 396-7, 565 P.2d 597 (1977). An order is 'lawful' if it is within the statutory authority of the commission and if the prescribed statutory and procedural rules are followed in making the order. Central Kansas Power Co. v. State Corporation Commission, 221 Kan. 505, Syl. P 1, 561 P.2d 779 (1977). An order is generally considered 'reasonable' if it is based on substantial competent evidence. Jones v. Kansas Gas and Electric Co., 222 Kan. 390, Syl. P 2, 565 P.2d 597.

"The legislature has vested the commission with wide discretion and its findings have a presumption of validity on review. Central Kansas Power Co. v. State Corporation Commission, 221 Kan. at 511, 561 P.2d 779. Since discretionary authority has been delegated to the commission, not to the courts, the power of review does not give the courts authority to substitute their judgment for that of the commission. Central Kansas Power Co. v. State Corporation Commission, 206 Kan. 670, 675, 482 P.2d 1 (1971). The commission's decisions involve the difficult problems of policy, accounting, economics and other special knowledge that go into fixing utility rates. It is aided by a staff of assistants with experience as statisticians, accountants and engineers, while courts have no comparable facilities for making the necessary determinations. Southwestern Bell Tel. Co. v. State Corporation Commission, 192 Kan. 39, 48-9, 386 P.2d 515 (1963). Hence a court may not set aside an order of the commission merely on the ground that it would have arrived at a different conclusion had it been the trier of fact. It is only when the commission's determination is so wide of the mark as to be outside the realm of fair debate that the court may nullify it. Kansas-Nebraska Natural Gas Co. v. State Corporation Commission, 217 Kan. 604, 617, 538 P.2d 702 (1975); Graves Truck Line, Inc. v. State Corporation Commission, 215 Kan. 565, Syl. P 5, 527 P.2d 1065 (1974)."

I.

The Commission's order fixed a rate of return, after operating expenses, of 3.43% on a total rate base, as adjusted, of $3,170,310. This assumed that, in line with Sekan's past practice, none of the net proceeds would be used to repay capital previously contributed by member-customers through paying rates in excess of the cost of service. (Systematic repayment of some of these "capital credits" of members each year is called "capital credit rotation."). The Commission also gave Sekan the option to demonstrate within sixty days that it intended to commence a capital credit rotation plan, in which case the rate of return would be increased to 4.81%. Sekan chose not to avail itself of this option, and the 3.43% rate went into effect.

The Commission's findings on the rate issue were based on the testimony of economist Jack T. Blakley, and a rejection of testimony offered by Sekan. Its reasoning is demonstrated by the following excerpt from its order:

"Mr. Blakley derived his 4.81% recommended rate of return by using a methodology that considered a return on equity, recovery of interest on funded debt, and the need for an electric cooperative to achieve a satisfactory times interest earned ratio (TIER). Mr. Blakley calculated the return on equity from a formula that takes into account the period of rotating capital credits designed by the cooperative and an anticipated rate of growth in total capitalization. Mr. Blakley's alternative rate of return, exclusive of an allowance for capital credit rotation, is 3.43% and represents the return Applicant needs to pay its interest obligations and provide a target TIER of approximately 2.25.

"The Commission finds that Applicant's requested rates of return overstate the Company's return requirements. Rate of return is supposed to provide for a return of equity and for cash to meet interest obligations. It is not designed to provide cash for repayment of debt principal or to offset the uncertain effect of inflation on operating and maintenance expenses. Mr. Glassman's testimony regarding the 10.50% rate of return on equity being less than the return allowed a publicly-owned utility, is not relevant to this proceeding. Equity in a electric cooperative represents the sum of members' mandatory payments in excess of all expenses, including interest expense."

It may be seen that the Commission did not "exclude" part of Sekan's equity capital. It simply adopted a rate to be applied to the entire rate base which allowed no "return" on equity, in the usual sense of corporate profits, at all. This result is justified by the fundamental difference between cooperatives and profit-making utilities. Cooperatives, unlike investor-owned utilities, do not secure equity by stock offerings in the marketplace, but by "overcharging" their customers and placing the surplus in their capital account. Hence a return large enough to pay dividends is not required to attract equity capital or to make a cooperative financially sound; it is enough that its rates safely cover its interest obligations to the federal lending agencies which furnish its long term debt capital (the "TIER" referred to by Blakley and in the order). The rate approved by the Commission meets this objective.

Sekan's argument about excluding part of its rate base is aimed primarily at the Commission's economist Blakley, who referred in his testimony to a "hypothetical equity ratio" of about 35%. It is conceded that Sekan's actual equity is about 55%, with the remaining 45% of its capital being long term debt. In computing an overall rate of return it is common to compute one rate on equity and a different rate on debt, and then allow a weighted average. That was done by Mr. Blakley in his alternative computation, but employing a hypothetical ratio rather than Sekan's actual ratio.

The authority of a commission to adopt a hypothetical equity ratio for rate of return purposes has been almost universally upheld in the courts. See E. Nichols, Ruling Principles of Utility Regulation, 267-273 (1955). The rationale was explained in E. Nichols and F. Welch, Ruling Principles of Utility Regulation, Rate of Return Supplement A, 157 (1964):

"It must be kept in mind, of course, that the regulatory commission does not have the actual authority to revise a utility's capital structure, per se, or to order the utility to change it into a different setup. That is a prerogative of management which cannot be superseded by the substitution of regulatory opinion that is to say, how much debt should be incurred or common stock issued.

"It is solely in the area of assuming what effect a different or more desirable capital structure would have on the cost of capital, if it were adopted, that the regulatory judgment may function. As a practical matter, of course, such a hypothetical assumption of an ideal or optimum capital structure, as distinguished from that which actually exists, may have the same dollars-and-cents results, as far as the return allowance is concerned, as an actual change in the capital structure. In other words, the regulatory authority may say to the utility company, in effect: 'We find that if the debt to equity ratio were different from what it actually is, your capital costs would be lower, so therefore we will consider the cost of capital just as if the capital structure were different, in making the return allowance.'

"This distinction between the function of management and that of the regulatory authority has been succinctly stated by the Maryland court of appeals in a recent decision (C. & P. Tel. Co. v. Public Service, 230 Md. 395, 187 A.2d 475 (1963)) wherein it...