RULES AND REGULATIONS
Title 52--PUBLIC UTILITIES
PENNSYLVANIA PUBLIC UTILITY COMMISSION
[52 PA. CODE CH. 53]
[L-930082]
Small Water and Sewer Company Rate Methodologies
[27 Pa.B. 301] The Pennsylvania Public Utility Commission (Commission) at a public meeting held August 8, 1996, adopted an order to promulgate a final regulation regarding the above-referenced subject. The regulations reduce regulatory burdens and paperwork requirements on small water and wastewater utilities seeking rate changes under the provisions of the Public Utility Code. The revisions permit small water and wastewater companies to establish emergency maintenance and operations funds, reserve accounts and to apply for a purchased water clause under 66 Pa.C.S. § 1307 (relating to sliding scale of rates; adjustments) if a substantial portion of their finished water is purchased from an independent entity.
At its public meeting of August 8, 1996, the Commission adopted an order issuing revisions and changes to its regulations which reduce regulatory burdens and paperwork requirements on small water and wastewater utilities seeking rate changes under the provisions of the Public Utility Code. The revisions permit small water and wastewater companies to establish emergency maintenance and operations funds, reserve accounts and to apply for a purchased water clause under 66 Pa.C.S. § 1307 (relating to sliding scale of rates; adjustments) if a substantial portion of their finished water is purchased from an independent entity.
These provisions were drafted under a petition by an ad hoc coalition of small water and wastewater utilities. They are intended to address the difficulty which some small utilities have in navigating the complex and expensive ratemaking process, and also to address the increasing capital demands placed on small companies as a result of increasingly stringent environmental and water quality regulations.
The contact persons are John A Levin, Law Bureau, telephone (717) 787-5978 and Shirley Leming, Law Bureau, 782-4597.
Regulatory Review
Under section 5(a) of the Regulatory Review Act (71 P. S. § 754.5(a)), the Commission submitted a copy of the final rulemaking, which was published at 24 Pa. B. 4594, and served on August 30, 1994, to the Independent Regulatory Review Commission (IRRC) and the Chairpersons of House Committee Consumer Affair and the Senate Committee on Consumer Protection and Professinal Licensure for review and comment. In compliance with section 5(b.1) of the Regulatory Review Act, the Commission also provided IRRC and the Committees with copies of all comments received as well as other documentation.
In preparing these final-form regulations, the Commission has considered all comments received from IRRC, the Committees and the public.
These final-form regulations was deemed approved by the House Committee on Consumer Affairs and were approved September 25, 1996, by the Senate Committee on Consumer Protection and Professional Licensure, and were disapproved by IRRC on October 3, 1996. A report and order was submitted to the legislative committees under section 7(b) of the Regulatory Review Act (71 P. S. § 754.7(b)) on November 4, 1996. No action was taken by the legislative committees and the regulations are thereby deemed approved.
Public Meeting held
August 8, 1996Commissioners Present: John M. Quain, Chairperson; Lisa Crutchfield, Vice Chairperson; John Hanger; David W. Rolka; Robert K. Bloom
Final Rulemaking Order By the Commission:
I. History of the Proceeding
With this order, the Commission hereby issues new rules with regard to alternative ratemaking for small water and sewer11 utilities. On June 28, 1993, the Commission issued an advance notice of proposed rulemaking at the above docket, published at 23 Pa.B. 3290 (July 10, 1993) and later issued a notice of proposed rulemaking (NPR) by order entered May 13, 1994, published at 24 Pa.B. 4594 (Sept 10, 1994). Comments on the proposed rulemaking were due on October 25, 1994. Four sets of comments were received.22
This rulemaking proceeding was prompted by a petition filed by an ad-hoc coalition of small water and wastewater companies (SURG) on May 29, 1992, at P-920583. SURG's petition prompted issuance of an Advance Notice of Proposed Rulemaking, in which the Commission circulated a draft of proposed regulations intended to address what SURG characterized as a serious problem afflicting small water and wastewater companies unable to cope with ratemaking procedures and the cost of rate litigation in a system originally designed to address the rates of large and sophisticated utilities.
These problems tend to afflict smaller, less sophisticated utilities--in particular, small water and sewage companies--many of whom (or whose predecessors) escaped regulation at the outset of operations. When all or most of a utility's rate base is excluded for either of these reasons, the utility earns little or no return on a per-books basis. As a consequence, rate base ratemaking fails to generate a return for small utilities that have little or no net rate base; this lack of return results in a situation where no revenue stream exists to finance normal operations and capital additions or improvements.SURG petition at 2.
This situation has become even more acute since 1992. Recent changes in environmental and clean water laws affect all water and wastewater utilities, regardless of size. Many small companies are now required to install and maintain expensive filtration, chlorination or waste treatment facilities, engage in sophisticated testing and comply with detailed environmental and safety reporting requirements. These increased obligations have resulted in the doubling or tripling of the annual cost of water for some companies, and has stressed some small water and wastewater company managements beyond their capabilities. Regionalization is one answer (that is, the merging or consolidation of smaller companies into bigger companies). Fifteen years ago, this Commission regulated approximately 400 small water and wastewater companies and company divisions. Through mergers and acquisitions, we now regulate approximately 210. However, regionalization is not a panacea, and many small water and wastewater companies and divisions are geographically isolated from other systems and may not be suitable for acquisition or merger.
We now count 81 of those companies as problem water companies (most of which report less than $250,000 in annual revenues). Each has recently been the subject of a large number of customer complaints alleging inadequate service, has experienced an income loss over a 2-3 year period, has not filed for a change in rates for a 3-5 year period, has been the subject of Department of Environmental Protection (DEP) water quality complaints or has failed to file annual reports with or pay assessments to this Commission in violation of 66 Pa.C.S. § 504 and 52 Pa. Code § 65.19. Our experience is that those five factors indicate financial and managerial problems which presage a steady downward spiral of service quality, and in serious cases, service interruptions or bankruptcy.
This is not a hypothetical problem. Six small water and wastewater companies in the Commonwealth have filed for Federal bankruptcy protection in the last 5 years. In our view, inflationary and regulatory pressures on small water and wastewater companies will not abate in coming years, but increase. Many communities which have heretofore relied upon individual residential and commercial wells and groundwater have already found or will shortly find such sources no longer available, environmentally restricted or contaminated. At the same time, new development continues in the Commonwealth, along with a continuing need for the creation and continued operation of small, regionally isolated water and wastewater companies. Such companies are often operated by a small developer or other real estate investor incidental to a subdivision of land, and are often staffed by no more than a handful of full time employes. These regulations address companies with gross annual revenues of $250,000 or less. Based upon typical residential bills of $250-500 annually per household, such companies might serve 500 to 1000 residential customers, but many are much smaller.
The typical public utility rate case involves the presentation of accounting, managerial, engineering, financial and other expert testimony and evidence. Rate base/rate of return regulation, which has been the ratemaking methodology used most commonly for fixed utilities such as water, wastewater, telecommunications, electric and gas utilities, has been based upon the reasonable assumption that such utilities are heavily capital intensive industries. It also assumes that the level of investment by the owners of the enterprise is a fair measure of the level of return which may be fairly demanded by such owners, and that therefore the valuation of the rate base of such utilities is a necessary element in determining what is a fair return, as a component of overall just and reasonable rates. Contested rate cases often require days of hearings, hundreds or even thousands of pages of transcript and the consideration of a mass of detailed data on plant valuation, depreciation, Federal and State taxation, applicable market rates of return, expected revenues under the proposed rates, expenses, test year normalizations of unusual or nonrecurring revenues and expenses, and rate structure issues. It is not unusual for small utilities to request recovery of $50,000 to $100,000 or more in rate case expenses, boosting the overall rate burden on customers. Because such companies have few customers, the burden is correspondingly greater, and rate case expense may easily comprise one quarter or more of the total annual cost of providing water service. Such costs do not include the costs expended by various governmental entities involved in the issues. The Commission and the Office of Consumer Advocate (OCA), the Office of Trial Staff (OTS), and the Office of Small Business Advocate (OSBA) are all funded through utility assessments.
The greatest regulatory problem with the rate base/rate of return paradigm is presented when a small water or wastewater utility has little or no rate base on which to base a return. That circumstance may come about in several different ways. An older utility may have reached full depreciation of its plant (mains, buildings, and the like) over the years, or the utility may have been constructed largely with customer contributions.
The Public Utility Code enjoins upon the Commission the duty to enforce the Public Utility Code (66 Pa.C.S. § 501), to assure that rates are just and reasonable (66 Pa.C.S. § 1301) and that service is adequate, efficient, safe and reasonable, and reasonably continuous (66 Pa.C.S. § 1501). It is nowhere enjoined upon the Commission that it must pursue these ends in an absurd manner, or to adhere to practices that have the paradoxical result of defeating the Public Utility Code's purpose and intent.
We regard the continued application of the rate base/rate of return model to small water and wastewater company rate cases as counterproductive and harmful to the public interest in some cases. It is poor public policy to continue practices which prevent small companies from obtaining legitimate revenue increases because they are legally or financially unable to navigate or fairly utilize the ratemaking process.
Since issuance of our proposed rulemaking in 1994, the Commonwealth Court has handed down a decision in Popowsky v. Pa.P.U.C., 674 A.2d. 1149 (Cmwlth. Ct. 1996) (LP Water and Sewer) with direct bearing on this rulemaking. The Court was squarely presented with the question of the lawfulness of the use of the operating ratio methodology in a challenge to a Commission rate order by OCA. The Court found that the Legislature has given the Commission considerable latitude to determine which is the appropriate rate setting methodology in any particular case, and that the Public Utility Code does not limit our discretion to use of the rate base/rate of return methodology. OCA had argued before the Court, as it argued previously in this rulemaking proceeding, that 66 Pa.C.S. § 1311(d) proscribes the use of an operating ratio for setting the rates of any utilities but ''common carriers.'' Our Commonwealth Court found, on the contrary, that:
[T]hat analysis is an incorrect reading of the statute. The statute only provides that public utilities which are engaged exclusively as common carriers may use an operating ratio. Section 1311(d) does not preclude the PUC from using such a ratio to set the rates of other public utilities...The code is silent as to what particular method the PUC must implement at arriving at a reasonable rate, and ''as long as there is a rational basis for the PUC's methodology, such decisions are left entirely up to the discretion of the PUC which, using its expertise, is the only one which can properly determine which method is the most accurate given the particular circumstances of the case and economic climate.''LP Water and Sewer at 1155, (citing West Penn Power v. Pa.P.U.C., 607 A.2d 1132, 1135 (1992)). We regard this case as dispositive of the challenges raised regarding the legality of the operating ratio methodology by commentors.
II. Comments
Four sets of comments, in addition to correspondence from the Chairperson of the House Consumer Affairs Committee, have been received with regard to the proposed rules. Comments were received from the Independent Regulatory Review Commission (IRRC), OCA, OTS and the Philadelphia Suburban Water Company (PSWC). The Honorable David R. Wright, who was then Majority Chairperson of the House Consumer Affairs Committee, states in a letter to the Commission that he has no comments with regard to the proposed regulations.
A. IRRC Comments
IRRC adopted OCA's comments with regard to the lawfulness of the operating ratio method of ratemaking. As this issue has now been resolved by the holding in L.P. Water & Sewer, we simply note that the operating ratio method is indeed lawful and authorized by the Public Utility Code. IRRC also adopts OCA's suggestion that the ''used and useful'' rule prohibits use of an Emergency Maintenance and Operation Fund (EMOF). We note that the ''used and useful'' rule prohibits the collection by a utility of a return upon plant that is not used or useful in the public service. While we allow no return on EMOF contributions, (and indeed, in an operating ratio environment, return on rate base is an irrelevant concept) the EMOF is clearly used and useful in that it provides a reserve for coping with emergencies in a manner similar to insurance, but with greater regulatory controls. We note, moreover, that customer contributions in aid of construction (with no return) are presumptively legal, commonplace and would be unlawful under IRRC's interpretation of the Public Utility Code.
IRRC has requested that we provide the ''approximate proportion of small water and sewer utilities in financial difficulties because of the ratemaking process and explain how the proposed regulation will alleviate this problem.'' A 1995 survey of water companies (not including small wastewater companies) indicates that nearly 80 companies are considered to be ''problem water companies'' throughout the Commonwealth and nearly all of which would qualify as small water companies under these rules. We believe that all or nearly all of these water companies are to some extent suffering financial difficulties because of the time, difficulty and expense associated with traditional rate base/rate of return formal ratemaking procedure. As we have noted elsewhere, regionalization is one solution to the problem of troubled small water and sewer companies, not the sole solution.
Neither law, nor sound public policy requires that this Commission pursue one solution to the exclusion of all others. Although IRRC appears to see a conflict between alternative ratemaking procedures for small companies and the regionalization effort, we believe that perception is incorrect. The goal remains, under any ratemaking methodology, to set ''just and reasonable'' rates. It cannot lawfully be the policy of the Commonwealth to make the ratemaking process so arduous and expensive that small companies cannot obtain the rate relief to which they are otherwise entitled. It is a fortiori more improper to, as IRRC and PSWC seem to suggest we do, create a difficult ratemaking environment solely to encourage small water and wastewater companies to sell out to larger companies.
With respect to IRRC's inquiry as to how many small water and sewer companies will qualify as small water and wastewater companies under these rules, according to 1995 annual reports, of 233 water utilities and 90 wastewater utilities reporting actual or estimated revenues in 1995, 172 water utilities and 69 wastewater utilities have revenue of $100,000 or less, 22 water utilities and 5 wastewater utilities have annual revenues of greater than $100,000 and less than $250,000 annually, and 39 water utilities and 16 wastewater utilities have annual revenues of greater than $250,000.
We believe that § 53.54(b)(2) and (4) adequately define the purpose and applicability of the operating ratio method and properly lays the burden of demonstrating its applicability in any particular rate case upon the utility desiring to employ the methodology. It would therefore be inadviseable to add language, as IRRC suggests, which further limits or defines the applicability of the methodology. We note that small companies may, through new construction, replacement of old plant or otherwise, acquire a sufficiently increased rate base so that use of the operating ratio methodology is no longer appropriate. It would be unwise to require that the operating ratio methodology be the subject of a one-time election, as IRRC suggests.
With respect to use of ''rate case history,'' ''quality of service'' and ''efficiency of operation'' and ''fairness of the resulting return,'' listed as subparagraphs (v), (vi) and (x), in § 53.54(b)(2), we note that we have no desire to utilize the operating ratio to ''prop up'' a hopelessly inefficient or mismanaged utility, nor to unjustly reward a utility with a record of management failure or which frequently files meritless or frivolous rate claims, and will take such factors into account in setting the operating ratio so as not to improperly reward such behavior. We believe that the operating ratio methodology should be informed, overall, by fairness. Since the ultimate test of all rates is whether they are ''just and reasonable,'' the fairness of the return resulting from the operating ratio method is highly relevant to our deliberations.
With regard to the purchased water cost adjustment, IRRC is correct that a utility which chooses to file such an adjustment tariff will be required to immediately reduce its rates and reflect the full cost reduction if the cost of purchased water goes down, but may only collect purchased water cost increases prospectively from the date of filing. This provision prevents companies from attempting to ''net out'' cost increases and decreases by delaying the reporting of purchased water cost decreases until later increases have ''netted out'' the difference.
We also decline IRRC's invitation to limit the applicability of emergency fund or reserve accounts to utilities which utilize an operating ratio. Small water and wastewater companies with limited access to capital have need of both devices whatever the ratemaking methodology.
B. OTS Comments
OTS, the prosecutorial office of the PUC, indicates that it ''has the same concerns about the revised proposal as it did regarding the original proposal'' and accordingly, attached a copy of its 1993 comments to our advance notice of proposed rulemaking, incorporating them by reference. As our notice of proposed rulemaking has adequately dealt with OTS's 1993 comments, we see no need to engage in further analysis.
OTS further asserts that 66 Pa.C.S. § 1315 prohibits ''rate base inclusion and any other form of rate recognition for capital plant expenditures relating to plant which is not yet used and useful in the public service.'' OTS thus opines that our proposed reserve fund violates § 1315, even though such funds are to be treated as ''customer contributions,'' and as a result do not provide any revenue available for return to the utility.
We believe that OTS has grossly misread § 1315. While the ''used and useful'' doctrine applies to all utilities, the cited section clearly applies only to ''electric utilities,'' and not to other utilities. This rulemaking proceeding is clearly limited to small water and wastewater utilities.
If we read OTS's comments to be founded instead upon the ''used and useful doctrine,'' again, we believe that OTS has misread the law. The EMOF and reserve fund provisions do not represent either an addition to rate base or a return of interest upon invested capital. Instead, both provisions are akin to customer contributions in aid of construction, or prepaid insurance provisions. A utility may not collect any interest or include any portion of either contribution in its rate base, assuming that it chooses to employ a rate base/rate of return methodology for claiming rate relief. We therefore reject OTS's comments with regard to the reserve fund.
C. OCA Comments
OCA filed more extensive comments. OCA suggests that raising the §§ 53.52(b)(2) and 53.54(a)(6) eligibility caps (for small water company rate treatment) is inappropriate. OCA suggests that the proposed cap, $250,000, would discourage regionalization. As we have noted elsewhere in this order, much regionalization has already been accomplished over the last 15 years and equally important, inflation continues to impact the present $100,000 threshold. It is only proper that fixed threshold numbers such as these either be indexed or periodically adjusted. Our judgment is that the annual revenue threshold of $250,000 will reach most of the smallest companies, that is to say, those with fewer than approximately 500 customers. While we support regionalization, it is not an end in and of itself, but a means of assuring service to customers who would otherwise be served by ailing or insolvent management. There may be many companies within the proposed threshold that are not easy candidates for regionalization, but which may be rehabilitated by the availability of appropriate rate relief.
OCA suggests that instead of utilizing operating ratio, we engage in an annual ''generic rate of return'' process for all small water companies. Small water companies would then file rate cases that would be resolved within the ''predetermined generic range of common equity'' determined in such annual proceedings. We do not understand how OCA's suggestion reduces the expense and difficulty of small water company rate proceedings, and note that OCA suggests that ''parties would retain the right to argue on the record as to the company's appropriate return on equity within the Commission's generic range or to argue that the company's return on equity should be outside that range.'' In our view, OCA's suggestion amounts to adding a generic annual proceeding on top of our existing rate setting process, with no benefit to either ratepayers or small water companies. For similar reasons, we reject OCA's suggestion to add additional filing requirements for small water and wastewater utilities.
OCA supports our proposed ''purchased water'' adjustment, but suggests that certain information be required to be filed to substantiate such cost changes. We believe the suggested language is appropriate and have largely adopted it.
OCA suggests that we adopt time limits for certificates of public convenience and certain notice requirements for initial service, abandonment or transfers of utility assets. While these are interesting concepts to which we have given some previous informal consideration, they are outside the scope of this rulemaking. We suggest that OCA raise these issues in a future application proceeding, or in the alternative, prepare a more detailed petition describing these proposals.
OCA argues that operating ratios are not permitted by the Public Utility Code. As noted above, the Commonwealth Court has held otherwise. With respect to the public policy arguments and suggested changes raised by OCA, they have been previously considered and rejected.
With respect to the proposed EMOF fund, OCA continues to oppose it on grounds similar to its comments in the proposed rulemaking proceeding. We note that a persistent theme in small water company crises and service difficulties is that inability of small companies to obtain access to capital. While larger companies can easily issue long-term debt or equity, small companies have neither the skill, financial stability nor economies of size and scale to consider borrowing from the public capital markets. Traditional borrowing sources are also difficult to access. Banks are understandably reluctant to lend money to small, troubled water companies. OCA's objections to EMOFs bear no rational relationship to the real problems faced by the small water and wastewater companies in this Commonwealth. Given the final rules' emphases on reporting and other requirements, there appears to be no need to impose third party escrow obligations on EMOFs.33 We reject OCA's comments with respect to reserve accounts for the same reasons.
D. PSWC Comments
PSWC filed comments essentially suggesting that these regulations would make it harder for PSWC to acquire small companies in regionalization efforts.
PSWC is concerned that, by making it easier for small troubled water companies to obtain rate relief, the Commission might inadvertently perpetuate their existence and/or encourage new, similarly ill-equipped, systems to commence operations, such as those created by real estate developers that become public utilities as a result of their building activities.It should be pointed out that not every troubled small water or wastewater company is well suited for acquisition by an existing large company. Regionalization has already been pursued for a number of years, and many of the obvious or easiest candidates for regionalization have already been merged into or acquired by stronger companies. Further, we do not regard the remedies as mutually exclusive. Finally, as PSWC correctly points out, many small water and wastewater companies are created as an incident to land development. We find PSWC's suggestion that these regulations will cause the sprouting of a new crop of financially unviable small water and wastewater utilities to be an unlikely scenario.
III. Conclusion
Accordingly, in order to enable the Commission to carry out its responsibilities under the Public Utility Code to ensure that water and wastewater service is rendered in accordance with the provisions of the Public Utility Code's requirements that service be rendered in a safe, adequate and reliable fashion at just and reasonable rates, the Commission is amending its regulations as described above and as set forth in the final-form regulations contained in Annex A. Under 66 Pa. C.S. §§ 1301--1304, 1307--1309, the Commonwealth Documents Law, 45 P.S. §§ 1201, et seq., and the regulations promulgated thereunder at 1 Pa. Code §§ 7.1--7.4, the Commission adopts these final-form regulations amending existing regulations at 52 Pa. Code §§ 53.52 and 53.54, as noted above and in the manner set forth in Annex A; Therefore,
It Is Ordered That:
1. The Commission's regulations at 52 Pa. Code Chapter 53, §§ 53.52 and 53.54 are amended as set forth at Annex A with ellipses referring to existing text.
2. The Secretary shall submit this order and Annex A to the House and Senate designated standing committees, and IRRC for formal review.
3. The Secretary shall submit this order and Annex A to the Office of Attorney General for approval as to legality and to the Governor's Budget Office for review of fiscal impact.
4. A copy of this order and Annex A shall be served upon the OCA, the OSBA, the OTS, and those persons who filed comments in response to our notice of proposed rulemaking.
5. The Secretary shall certify and deposit this order and Annex A with the Legislative Reference Bureau for publication in the Pennsylvania Bulletin.
6. These amendments shall become effective immediately upon publication in the Pennsylvania Bulletin.
Public Meeting held
November 1, 1996Commissioners Present: John M. Quain, Chairperson; Lisa Crutchfield, Vice Chairperson; John Hanger; David W. Rolka; Robert K. Bloom
REPORT AND ORDER By the Commission:
On October 11, 199614 , the Independent Regulatory Review Commission (IRRC) disapproved our final-form regulation with regard to an alternative form of rate regulation of small water and wastewater utilities, which we adopted at public meeting on August 8, 1996, and which was presented for regulatory review on September 13, 1996. On October 18, 1996, the Public Utility Commission (Commission) notified the Governor, the designated standing committees of the Legislature, and IRRC of our intention to implement the final-form regulations without revisions or further modification, pursuant to the relevant provisions of the Regulatory Review Act, 71 P.S. § 745.7(a). Pursuant to the act, we are required to:
submit a report to the designated standing committee of each House of the General Assembly, and [IRRC] within 40 days of the agency's receipt of [IRRC's] disapproval order. The agency's report shall contain the final-form regulation, the findings of [IRRC], and the response and recommendations of the agency regarding the final-form regulation.As we have noted in earlier orders at this docket, this rulemaking was prompted by a call for help from an ad hoc group of small water and sewer utilities who told the Commission in a 1992 petition that the expense and complexity of the existing regulatory scheme was endangering the viability of very small water and sewer utilities.
The call for help was in the form of a petition filed by an ad-hoc coalition of small water and wastewater companies (SURG) on May 29, 1992 at P-920583. At that time, SURG told the Commission that:
At issue are problems with exclusion of plant due to inadequate original cost records or findings of indirect or imputed contributions in aid of construction. These problems tend to afflict smaller, less sophisticated utilities--in particular, small water and sewage companies--many of whom (or whose predecessors) escaped regulation at the outset of operations...Small water and sewage utilities with little or no rate base must be given an opportunity to earn real and reasonable revenues (as opposed to the hypothetically adequate revenues which result when the majority of plant in use and in service is deleted from the ratemaking process), if they are to be able to render safe, adequate and reasonable service...Some attempt should be made to at least use per books income and expenses as a check as to the adequacy of revenues, because viability is not truly a ratemaking function, but a function of business reality. And, neither the industry, nor the regulators can, in the long-term, ignore the fact that the capital improvements now facing large and small water companies alike will require massive infusions of capital which will not be forthcoming if the borrowing utility is a real-world financial cripple. Furthermore, PENNVEST cannot and will not be available for all the necessary borrowing because its funds are limited and because even PENNVEST requires some level of financial well-being.SURG proposed amendments to Title 52, Chapter 53 which formed the basis of these final regulations, but which were extensively modified by the Commission during the promulgation of these regulations. It is notable, however, that the SURG draft contained provisions permitting use of an operating ratio method of ratemaking for small water and sewer utilities, permitted creation of an Emergency Maintenance and Operation Fund and a Reserve Account to be funded as ''customer contributions in aid of construction.'' The significance of that accounting designation is that such funds would be considered to be ratepayer capital, not shareholder capital, and the utility would not be permitted to earn a return upon, nor charge depreciation upon assets or expenditures derived from either fund.
It is also significant that the Office of Consumer Advocate (OCA), which responded to the SURG petition on June 19, 1992, supported such a rulemaking, although it ''disagrees with several of the specific statements and recommendations contained in the Petition.'' OCA proposed that with regard to the ''reserve account'' proposed by SURG, that:
the utility should be required to request the establishment of a reserve account as part of its initial rate filing...In addition, any type of reserve account mechanism must have certain protections. For example, the money contained in the fund should be treated as customer contributions...In short, the OCA sees a reserve account with proper restrictions as a possible short term measure until the utility is in an improved financial position.OCA Answer to SURG Petition, page 2.
OCA similarly approved of the use of the operating ratio methodology and the Emergency Maintenance and Operation Fund in principle, although it wished to impose much stronger safeguards than those originally proposed by SURG.
In response to SURG's petition and the responses thereto, including OCA's response, the Commission issued an Advance Notice of Proposed Rulemaking (ANPR) at 23 Pa. B. 3290 (July 10, 1993). The ANPR utilized SURG's petition as a model, although SURG's provisions were significantly redrafted and modified to better meet the public interest and impose safeguards of the kind suggested by OCA.
OCA did not like the ANPR draft, and (for the first time) suggested that not only was the ANPR unwise, but as to the operating ratio and funding provisions, that it was statutorily without support and contrary to the provisions of the Public Utility Code. OCA's change in legal position has formed the primary basis of IRRC's opposition to and disapproval of these regulations, and has already proven to be erroneous when tested before our appellate courts.
After these regulations were promulgated in proposed form in 1994, 24 Pa. B. 4594 (September 10, 1994), OCA continued its opposition, asserting, among other things, that the operating ratio methodology was unlawful, pursuant to OCA's interpretation of 66 Pa.C.S. § 1311. IRRC filed comments on November 28, 1994, which essentially adopted OCA's legal position. IRRC, echoing the OCA analysis, specifically asserted in its comments that 66 Pa.C.S. § 1311(d) is evidence that ''if the legislature had intended to allow operating ratios to be used to establish rates for water and small utilities (sic), it would have expressly provided for such as it did for common carriers in Section 1311(d).''
That judgment, which turned upon an erroneous application of statutory construction principles, was finally revealed as erroneous by a 1996 decision of the Commonwealth Court of Pennsylvania, Popowsky v. Pa.P.U.C., 674 A.2d. 1149 (Cmwlth. Ct. 1996) (LP Water and Sewer), in which OCA had an opportunity to test its legal theories in front of a panel of experienced appellate judges. The Court was squarely presented with the question of the lawfulness of the use of the operating ratio methodology in a challenge to a Commission rate order by OCA. The Court found that the Legislature has given the Commission considerable latitude to determine which is the appropriate rate setting methodology in any particular case, and that the Public Utility Code does not limit our discretion to use of the rate base/rate of return methodology.
OCA had argued before the Court, as it argued previously in this rulemaking proceeding, that 66 Pa.C.S. § 1311(d) proscribes the use of an operating ratio for setting the rates of any utilities but ''common carriers.'' Commonwealth Court found, on the contrary, that:
[T]hat analysis is an incorrect reading of the statute. The statute only provides that public utilities which are engaged exclusively as common carriers may use an operating ratio. Section 1311(d) does not preclude the PUC from using such a ratio to set the rates of other public utilities...The code is silent as to what particular method the PUC must implement at arriving at a reasonable rate, and ''as long as there is a rational basis for the PUC's methodology, such decisions are left entirely up to the discretion of the PUC which, using its expertise, is the only one which can properly determine which method is the most accurate given the particular circumstances of the case and economic climate.''LP Water and Sewer at 1155, (citing West Penn Power v. Pa.P.U.C., 607 A.2d 1132, 1135 (1992))
IRRC's 1994 comments also cited and adopted a variety of other reasons for its opposition: that there was no evidence that an operating ratio method was supported by economic and financial theory, that establishment of an EMOF fund and Reserve account were prohibited by the ''used and useful'' rule of utility ratemaking (another legal position espoused by OCA), and that the proposed purchased water provision should be drafted so as to require water utilities to reflect both decreases and increases in an updated purchased water rate (as drafted, the provision requires passthrough of decreases, but allows utilities to absorb increases at their discretion).
We carefully considered the comments of IRRC and those of the other three commenting parties, and on August 14, 1996, issued final rules substantially similar to those issued in proposed form. On September 25, 1996, the Senate Consumer Affairs and Professional Licensure Committee approved this final-form rulemaking. The House Consumer Affairs Committee took no action with respect to these rules at its October 2, 1996, meeting, causing these regulations to be ''deemed approved'' pursuant to 71 P. S. § 745.5(c).
On October 3, 1996, IRRC met to consider this rulemaking, among others. While the IRRC Commissioners expressed sympathy for the goals of this rulemaking, they also expressed an opinion, based upon the OCA legal analysis, that the Public Utility Code prohibited the result. As discussed below, neither the Public Utility Code, nor the ''used and useful'' rule are inimical to these regulations. IRRC's opinion to the contrary is based upon an erroneous reading of the law and a misreading of ratemaking procedures.
Before discussing the legal issues, it is desireable to revisit the policy considerations which prompted the original petition and the final-form rulemaking.
According to 1995 annual reports, of 233 water utilities and 90 wastewater utilities reporting actual or estimated revenues in 1995, 172 water utilities and 69 wastewater utilities have revenue of $100,000 or less, 22 water utilities and 5 wastewater utilities have annual revenues of greater than $100,000 and less than $250,000 annually, and 39 water utilities and 16 wastewater utilities have annual revenues of greater than $250,000. Since the final-form rules target small water and wastewater utilities with annual revenues of $250,000 or less, we believe that they are properly designed to address the problems we have identified as unique to small water and wastewater utilities.
There is a continuing crisis for small water and wastewater utilities in the Commonwealth due to several recurring factors. First, small companies have problems of economy of scale, management, and access to capital that do not weigh as heavily upon larger companies. Secondly, all water and wastewater utilities, but especially the smaller companies, have been hard pressed to meet the increasingly stringent requirements of environmental legislation and regulation. Third, navigating the sometimes highly complex, technical and arduous process of public utility ratemaking can challenge even a well funded utility with expert legal assistance. Small companies may find that their relatively modest requests for rate relief are largely eaten up, or even dwarfed, by the cost of preparing technical and legal submissions that are required in a traditional, full-blown, rate base/rate of return proceeding.
It is our intention under these rules to relieve the smallest water and wastewater utilities of a significant portion of the unnecessary regulatory burden of justifying necessary rate relief, while retaining all of our necessary powers to curb waste, fraud and managerial abuse of discretion. In addition, we intend to provide such small utilities with the ability to meet their obligations to timely comply with their environmental and operational obligations by providing them a way to fund such obligations in a manner that substantially benefits their ratepayers.
Finally, we intend to permit small water utilities, many of whom purchase the bulk of their water in finished form from another utility, to quickly reflect purchased water cost increases and decreases without the need for filing a comprehensive and logically unnecessary base rate case.
Recent changes in environmental and clean water laws affect all water and wastewater utilities, regardless of size. Many small companies are now required to install and maintain expensive filtration, chlorination or waste treatment facilities, engage in sophisticated testing and comply with detailed environmental and safety reporting requirements. These increased obligations have resulted in the doubling or tripling of the annual cost of water for some companies, and has stressed some small water and wastewater company managements beyond their capabilities. Regionalization is one answer (that is, the merging or consolidation of smaller companies into bigger companies). Fifteen years ago, this Commission regulated approximately 400 small water and wastewater companies and company divisions. Through mergers and acquisitions, we now regulate approximately 210. However, regionalization is not a panacea, and many small water and wastewater companies and divisions are geographically isolated from other systems and may not be suitable for acquisition or merger.
We now count 81 of those companies as problem water companies (most of which report less than $250,000 in annual revenues). Each has recently been the subject of a large number of customer complaints alleging inadequate service, has experienced an income loss over a 2-3 year period, has not filed for a change in rates for a 3-5 year period, has been the subject of Department of Environmental Protection (DEP) water quality complaints or has failed to file annual reports with or pay assessments to this Commission in violation of 66 Pa.C.S. § 504 and 52 Pa. Code § 65.19. Our experience is that those five factors indicate financial and managerial problems which presage a steady downward spiral of service quality, and in serious cases, service interruptions or bankruptcy.
This is not a hypothetical problem. Six small water and wastewater companies in the Commonwealth have filed for Federal bankruptcy protection in the last 5 years. In our view, inflationary and regulatory pressures on small water and wastewater companies will not abate in coming years, but increase. Many communities which have heretofore relied upon individual residential and commercial wells and groundwater have already found or will shortly find such sources no longer available, environmentally restricted or contaminated. At the same time, new development continues in the Commonwealth, along with a continuing need for the creation and continued operation of small, regionally isolated water and wastewater companies. Such companies are often operated by a small developer or other real estate investor incidental to a subdivision of land, and are often staffed by no more than a handful of full time employes. These regulations address companies with gross annual revenues of $250,000 or less. Based upon typical residential bills of $250-500 annually per household, such companies might serve 500 to 1,000 residential customers, but many are much smaller.
The typical public utility rate case involves the presentation of accounting, managerial, engineering, financial and other expert testimony and evidence. Rate base/rate of return regulation, which has been the ratemaking methodology used most commonly for fixed utilities such as water, wastewater, telecommunications, electric and gas utilities, has been based upon the reasonable assumption that such utilities are heavily capital intensive industries. It also assumes that the level of investment by the owners of the enterprise is a fair measure of the level of return which may be fairly demanded by such owners, and that therefore the valuation of the rate base of such utilities is a necessary element in determining what is a fair return, as a component of overall just and reasonable rates. Contested rate cases often require days of hearings, hundreds or even thousands of pages of transcript and the consideration of a mass of detailed data on plant valuation, depreciation, Federal and State taxation, applicable market rates of return, expected revenues under the proposed rates, expenses, test year normalizations of unusual or nonrecurring revenues and expenses, and rate structure issues. It is not unusual for small utilities to request recovery of $50,000 to $100,000 or more in rate case expenses, boosting the overall rate burden on customers.
Because such companies have few customers, the burden is correspondingly greater, and rate case expense may easily comprise one quarter or more of the total annual cost of providing water service. Such costs do not include the costs expended by various governmental entities involved in the issues. The Commission, the Office of Consumer Advocate, the Office of Trial Staff, and the Office of Small Business Advocate are all funded through utility assessments.
The greatest regulatory problem with the rate base/rate of return paradigm is presented when a small water or wastewater utility has little or no rate base on which to base a return. That circumstance may come about in several different ways. An older utility may have reached full depreciation of its plant (mains, buildings, and the like) over the years, or the utility may have been constructed largely with customer contributions.
The Public Utility Code enjoins upon the Commission the duty to enforce the Public Utility Code (66 Pa.C.S. § 501), to assure that rates are just and reasonable (66 Pa.C.S. § 1301) and that service is adequate, efficient, safe and reasonable, and reasonably continuous (66 Pa.C.S. § 1501). It is nowhere enjoined upon the Commission that it must pursue these ends in an absurd manner, or to adhere to practices that have the paradoxical result of defeating the Public Utility Code's purpose and intent.
We regard the continued application of the rate base/rate of return model to small water and wastewater company rate cases as counterproductive and harmful to the public interest in some cases. It is poor public policy and false economy to prevent small companies from seeking and obtaining otherwise legitimate revenue increases simply because of an inability to legally or financially navigate or fairly utilize the ratemaking process.
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1''Sewer'' utilities are increasingly coming to be known as ''wastewater'' utilities. We have conformed with this change in the text of this order and in the proposed regulations. We do not intend any substantive change as a result.
2Comments were received from IRRC, Office of Trial Staff, Office of Consumer Advocate and Philadelphia Suburban Water Company as well as correspondence from the Honorable David R. Wright, who was then Chairperson of the Consumer Affairs Committee of the House of Representatives.
3OCA did not supply amemdatory language for any of its suggested changes, as we requested in paragraph 2 of our order.
4IRRC amended its order on October 15, 1996, correcting its erroneous statement that this rulemaking had been disapproved by the Senate Committee on Consumer Affairs and Professional Licensure. In fact, the rulemaking was approved by the Senate Committee on September 25, 1996, and was ''deemed approved'' by the House Consumer Affairs committee through inaction at its meeting on October 2, 1996.
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