[27 Pa.B. 301]
[Continued from previous Web Page] IRRC Order of Disapproval
IRRC's Order on Regulation No. 57-149, Small Water and Sewer Company Rate Methodologies raises three major issues: the purported unlawfulness of the Emergency Operations and Maintenance Fund (EMOF) and Reserve Accounts, the justification for use of an operating ratio, and finally, the technical construction of the purchased water adjustment clause. We will take each of those objections in order:
IRRC Challenge to Lawfulness of EMOF and Reserve Account
As noted above, OCA originally had no legal objection to these funds, but suggested that both should be accompanied by stronger safeguards against misuse. We have significantly strengthened and improved such safeguards from the proposal originally made by OCA. Such safeguards ensure both that the funds are administered reasonably, and that the funds are applied for the purpose of providing service to the public.
IRRC and OCA now contend that both funds run afoul of the ''used and useful'' rule, which has been applied in many years of decisions both in this Commonwealth and in other states, and as explicated by the Supreme Court in Barasch v. Pa.P.U.C., 516 Pa. 142, 532 A.2d 325 (1987), affirmed sub nom: Duquesne Light Co. v. Barasch, 488 U.S. 299, 102 L.Ed. 2d 646, 109 S. Ct. 609, (1989). In that case, the Supreme Court heard an appeal from this Commission's allowance of the $34.7 million cancellation cost of four nuclear power plants. The Supreme Court, interpreting the provisions of a newly enacted provision of the Public Utility Code, 66 Pa.C.S. § 1315, held that it was an expression of general ratemaking law in Pennsylvania which prohibited utilities from earning a return upon, or recovering the costs through rates of any facility which not ''used and useful'' in the public service.
In that decision, the Supreme Court took pains to distinguish the matter at issue (cancellation costs for a facility which would never provide service to the public) from costs for plant which could and probably would provide service to the public in the future. Citing Barasch v. Pa.P.U.C., 507 Pa. 430, 490 A.2d 806 (1985), the Supreme Court distinguished the inclusion in rate base of nuclear fuel purchased for use in an uncompleted nuclear power plant, stating:
In that case, we held that a utility could properly include in its rate base the cost of nuclear fuel purchased for use in an uncompleted nuclear plant. However, an important fact in that case was that the fuel could also have been used in other facilities that were currently in service. Utilities have traditionally been allowed to recover the cost of useable supplies and materials.Barasch, 516 at 163, 532 A.2d at 335 (note 8)
The major problem with IRRC's analysis is that it lacks an essential grounding in the distinction between plant which may be included in rate base, akin to a utility investment (the basis of the utility's claim for a fair return) and customer contributions, which are decidedly not utility investments, and upon which the utility is entitled to no return, nor depreciation, and which are for the benefit of ratepayers, not utility shareholders. Funding through customer contributions does not create a rate base issue which is suceptible to the ''used and useful'' analysis employed by IRRC and OCA. IRRC's analysis is also not informed by the myriad of situations, even in traditional rate base/rate of return proceedings, in which utilities are permitted to recover expenses, or to claim rate base costs25 which have some element of future service to them. Insurance premiums are one example of ''rates now for future benefits'' on the expense side, cash working capital, decommissioning expense, capitalized pension benefits and qualified land held for future use constitute examples on the rate base side.
More recently, the Barasch ''used and useful rule'' has been narrowed by the Supreme Court. In Popowsky v. Pa.P.U.C., 165 Pa. Commonwealth Ct. 605, 645 A.2d 912 (1994), the Commonwealth Court found that it was error for the Commission to permit Metropolitan Edison to recover $68 million in decommissioning costs (the cost of radiological decommissioning and the costs of removing nonradiological facilities and structures of Three Mile Island 2, a plant which was destroyed by a 1979 accident), because the plant ''will not now or ever provide utility service to MetEd's customers.'' The Supreme Court reversed in Popowsky v. Pa.P.U.C., 542 Pa. 99, 665 A.2d 808, narrowing its 1987 Barasch case, and holding that:
Given what we have already said about the fundamental principles of this state's public-utility jurisprudence, it should be clear that no utility of any type is permitted, without express and valid legislative authorization, to charge ratepayers for property which is not used and useful in the production of current utility service (citation omitted). Nevertheless, to charge ratepayers for decommissioning costs is perfectly consistent with the cited language from Barasch. When ratepayers pay decommissioning costs, they are not reimbursing the utility for the cost of the power plant itself. Nor are they providing a rate of return on the utility's investment in the plant...Barasch was not intended as a sweeping change in the law defining ratepayer liability for operating expenses of utilities. Rather, it was an application of 66 Pa.C.S. § 1315, holding that construction costs for canceled nuclear power plants could not be charged to ratepayers, regardless of whether the utility labeled the expenditures as construction costs or operating expenses.Utilities have not been limited to charging ratepayers for only those expenses which directly and immediately supply commodities to their customers (citations omitted). Clearly the costs of providing present utility service are more encompassing. One such cost is that of maintaining compliance with federal laws governing removal of radioactive contamination...In determining just and reasonable rates, the PUC has discretion to determine the proper balance between interests of ratepayers and utilities...There is ample authority for the proposition that the power to fix ''just and reasonable'' rates imports a flexibility in the exercise of a complicated regulatory function by a specialized decision-making body and that the term ''just and reasonable'' was not intended to confine the ambit of regulatory discretion to an absolute or mathematical formulation, but rather to confer upon the regulatory body the power to make and apply policy concerning the appropriate balance between prices charged to utility customers and return as on capital to utility investors consonant with constitutional protections applicable to both...Further, the PUC is obliged to consider broad public interests in the rate-making process.Popowski, at 542 Pa. 106-107, 665 A.2d at 811-812 (1995).
It should be emphasised that the ''used and useful'' line of cases are specifically concerned with rate base claims, that is, utility assets which are claimed by a utility as part of its rate base, upon which it is entitled to earn a return. These regulations have been specifically drafted to prevent either EMOF or Reserve Account funds from being claimed as part of a utility's rate base. Instead, they are specifically drafted and defined as ''customer contributions'' which may not be the basis of a utility return claim, may not be the basis of a utility depreciation claim, and are subject to strict and extensive PUC oversight with regard to utilization and disbursement. Moreover, with regard to the EMOF fund, the regulations specifically prescribe that if claimed, it shall be in lieu of any ''cash working capital'' claim, a rate base claim that is both lawful for ratemaking purposes and a component of nearly every utility rate filing in Pennsylvania. Pittsburgh v. Pa.P.U.C., 169 Pa. Superior Ct. 400, 82 A.2d 515.
IRRC's error arises out of its dismissal of the material distinction between plant constructed with investor assets, and customer contributions in aid of construction. Customer contributions in aid of construction have a long history in the ratemaking process, both in Pennsylvania and elsewhere. There are many situations in which utility plant may be funded with customer contributions rather than with ratepayer investment. In the end, the decision is based upon the Commission's determination of the public interest.
The Commission has found that small water and sewer companies have significant and continuing problems financing both ordinary needed improvements to their systems, and the additional improvements required as a result of the recent tightening of environmental and water quality laws. Small companies are typically unable to obtain access to bond or equity financing in the National capital market, are not attractive candidates for bank or other secured loan financing, and may have few or no cash reserves from which to self fund such improvements. The improvements and expenditures which will be made through the EMOF and Reserve Account funds directly benefit all customers of such small utilities. Not only is there no practical alternative to customer contributed funds, such funding actually saves ratepayers money in that they are not required to pay the utility a return on contributed capital, nor to pay annual depreciation charges on plant and facilities constructed through customer contributions. Given the choice between no service or poor service and good service at reasonable rates, it appears that customer contributed funding of the EMOF and Reserve Accounts is in the public interest.
IRRC also cites Barasch, et al v. Pa.P.U.C., 127 Pa. Commonwealth Ct. 544, 562 A.2d 414 (1989) (Staffaroni) [which it incorrectly styles as Staffaronei v. Pa.P.U.C.]. Staffaroni involved recovery of interest expense related to PENNVEST financed facilities which were not used after construction because they were found to be contaminated with high levels of barium. The Staffaroni court found that the facilities were not ''used and useful'' because they were not, in fact of use to the public. That case is easily distinguished as a classic application of the ''used and useful'' doctrine to prohibit the earning of a return upon facilities that do not serve the public. We conclude that the Staffaroni case simply does not speak to the issue of the lawfulness of these regulations which create a fund from customer contributions that does not result in any profit or return to the utility and which is directly supervised by the Commission to ensure that the fund is used for projects which do in fact benefit the public. The Commission urges the Legislature to approve these provisions as being manifestly in the public interest.
IRRC Challenge to Use of Operating Ratio
As noted above, IRRC originally adopted OCA's position during consideration of the proposed form of these regulations that use of an operating ratio methodology for small water and wastewater utilities is prohibited by 66 Pa. C.S. § 1311(d), despite our explanation that that provision is permissive rather than prohibitory. The Commission was able to lay that erroneous interpretation to rest in the LP Water & Sewer decision of Commonwealth Court. IRRC's fallback position is to question the wisdom of the operating ratio, contending its appropriateness. It appears that IRRC both overlooks the long history of the use of the operating ratio methodology in transportation rate proceedings in the Commonwealth, and also overlooks the obvious benefits in rate case streamlining which the operating ratio methodology offers small companies.
First, the operating ratio methodology is not new. It has been specifically authorized for use in transportation rate proceedings for many years. In summary, the operating ratio methodology permits the Commission and the parties to a rate case to agree upon a barometer group of similar companies, analyse their ratio of revenues to a reasonable estimate of expenses and derive an appropriate operating ratio to determine what level of operating revenue (profit) is reasonable under the circumstances. It does not forclose a detailed analysis of the instant utility's actual operating expenses, which continue to be subject to examination for reasonableness and prudence.
It should be pointed out that the traditional rate base/rate of return methodolgy is a legal construct and not the product of academic research. Because utilities are traditionally capital intensive, Pennsylvania, and many other jurisdictions have utilized the value of the utility rate base as a measure of the utility's investment and have applied market derived earnings data to that rate base as the basis for estimating what constitutes a fair return to the company.
What works for a large utility is not necessarily appropriate for a small utility or one without a substantial rate base. The cost of presenting a traditional rate base/rate of return case is driven partly by legal expense and partly by the expense of presenting witnesses in the various specialized issues. Utilization of an operating ratio methodology both ensures just and reasonable rates and substantially reduces rate case expense by eliminating the need for valuation and rate of return testimony and the compilation of expensive studies on those two subjects. While IRRC questions the rate case savings which may result from a switch in methodologies, our extensive experience with rate case litigation over many years persuades us that the savings are real and will be significant.
Secondly, use of the operating ratio methodology substantially simplifies and reduces many of the complex and somewhat arcane disputes which surround every rate case with regard to the determination of the appropriate test year rate base level, and the appropriate determination of market data to be employed to determine the appropriate fair rate of return to apply to the utility's rate base. For very small companies, these weighty disputes may have little impact in terms of overall rates, but drive up the cost, and time required to complete a contested ratemaking proceeding. Sending small water and wastewater companies through a rate setting procedure designed and tested for setting rates for sophisticated multi-million dollar utilities is like swatting a fly with a trip hammer. Accordingly, the Commission urges the General Assembly to approve these regulations with regard to use of the operating ratio methodology.
IRRC Opposition to Purchased Water Adjustment
IRRC appears not to have any objection to the purchased water provision of § 53.54(c) in general, but objects to its application in certain situations. As written, the provision permits any small water utility to file a sliding scale rate tariff, pursuant to 66 Pa.C.S. § 1307, to recover the cost of water it purchases from another water system. Small systems often purchase finished water from other systems, often from municipal systems, and distribute it for resale to their own customers. Even a system with its own supply and treatment facilities may need to purchase water on occasion in the event of facility unavailability. Section 53.54(c) requires that small utilities immediately reflect and pass through to their rate payers any reduction in the cost of purchased water, but leaves it up to management discretion whether to, and when to pass through any increases. If management decides to recover such increases, they must act promptly to file for a change in the sliding scale rate, as recovery of increases is permitted only from the date of filing. IRRC finds that distinction to be unfair, and opines that ''this could result in a utility not being able to recover a significant portion of all its costs.''
The provision was drafted to give utility managers some leeway and discretion. A generally applied rule of ratemaking is that utilities should always be permitted to voluntarily absorb cost increases instead of passing those increases on to customers. We can envision a number of reasons why a prudent management would wish not to pass along a temporary or relatively minor increase in purchased water costs. We also expect utility management to be aware of their rights and obligations. We therefore do not completely understand IRRC's insistence that utility management needs to be protected from itself by requiring the pass through of cost increases which might otherwise be absorbed at management's discretion. We believe the provision to be a major improvement from the present situation in which small utilities must file a comprehensive rate case to recover any change in purchased water costs.
In sum, we believe these provisions are in the public interest and urge the General Assembly to approve them as drafted; Therefore,
It is Ordered:
1. This Report and Order containing the response and recommendations of this Commission, and Annex A, consisting of the final-form regulations and the findings of IRRC shall be served forthwith upon the designated standing committees of each House of the General Assembly, and IRRC.
5. Upon approval or acquiescence in accordance with 71 P. S. § 745.7(d), the Secretary shall certify and deposit this order and the final-form regulations with the Legislative Reference Bureau for publication in the Pennsylvania Bulletin.
6. These regulations shall become effective immediately upon publication in the Pennsylvania Bulletin.
JOHN G. ALFORD,
Secretary(Editor's Note: For the text of the order of the Independent Regulatory Review Commission relating to this document, see 26 Pa.B. 5181 (October 26, 1996).)
Fiscal Note: Fiscal Note 57-149 remains valid for the final adoption of the subject regulations.
Annex A
TITLE 52. PUBLIC UTILITIES
PART I. PUBLIC UTILITY COMMISSION
Subpart C. FIXED SERVICE UTILITIES
CHAPTER 53. TARIFFS FOR NONCOMMON CARRIERS
INFORMATION FURNISHED WITH THE FILING OF RATE CHANGES § 53.52. Applicability; public utilities other than canal, turnpike, tunnel, bridge and wharf companies.
* * * * * (b) Whenever a public utility other than a canal, turnpike, tunnel, bridge or wharf company files a tariff, revisions or supplement which will increase or decrease the bills to its customers, it shall submit in addition to the requirements of subsection (a), to the Commission, with the tariff, revision or supplement statements showing all of the following:
* * * * * (2) The operating income statement of the utility for a 12-month period, the end of which may not be more than 120 days prior to the filing. Water and wastewater utilities with annual revenues under $250,000 and municipal corporations subject to Commission jurisdiction may provide operating income statements for a 12-month period, the end of which may not be more than 180 days prior to the filing.
* * * * * (c) If a public utility files a tariff, revision or supplement which it is calculated will increase the bills of a customer or a group of customers by an amount, when projected to an annual basis, exceeding 3% of the operating revenues of the utility--subsection (b)(4) divided by the operating revenues of the utility for a 12-month period as defined in subsection (b)(2)--or which it is calculated will increase the bills of 5% or more of the number of customers served by the utility--subsection (b)(3) divided by subsection (a)(2)--it shall submit to the Commission with the tariff, revision or supplement, in addition to the statements required by subsections (a) and (b), all of the following information:
(1) A statement showing the utility's calculation of the rate of return or operating ratio (if the utility qualifies to use an operating ratio under § 53.54 (relating to small water and wastewater utililities)) earned in the 12-month period referred to in subsection (b)(2), and the anticipated rate of return or operating ratio to be earned when the tariff, revision or supplement becomes effective. The rate base used in this calculation shall be supported by summaries of original cost for the rate of return calculation. When an operating ratio is used in this calculation, it shall be supported by studies of margin above operation and maintenance expense plus depreciation as referred to in § 53.54(b)(2)(B).
* * * * * § 53.54. Small water and wastewater utilities.
(a) Procedures.
(1) Whenever a small water or wastewater utility desires to file a change in its tariff which increases annual revenues, it may advise the Commission of its intention in letter form and request the necessary Commission forms. When filing, the utility shall set forth its proposed tariff changes and reasons for the changes, together with the necessary completed Commission forms. If the utility is unable to fully complete the necessary forms, it may request assistance from the Commission staff.
(2) The small water utility or wastewater utility is required to fully cooperate with the Commission staff in providing the necessary information to complete these forms if the utility is unable to do so on its own.
(3) Upon completion of the Commission forms in a manner satisfactory to the Commission staff, the small water or wastewater utility shall file a tariff or tariff supplement, along with the completed forms, incorporating the proposed changes. The effective date of the proposed increase contained in the tariff or tariff supplements may not be less than 61 days after the filing, and customers shall be notified in accordance with § 53.45(a)(2) (relating to notice of new tariffs and tariff changes).
(4) On the basis of the tariff filing, the accompanying data and completed forms, the staff shall determine tentative allowable revenues and submit a report to the Commission.
(5) If the proposed revenues exceed the tentative allowable revenues, the Commission will suspend the supple- ment but with a ''condition subsequent'' added, to the effect that if the utility within a specified number of days files a superseding supplement which produces the allowable revenues found by the staff and which has a rate structure satisfactory to the Commission, the suspension and investigation orders of the Commission shall be deemed inoperative and terminated. However, if the utility fails to meet the ''condition subsequent,'' or if a customer files a formal complaint, the utility may present the supporting data and the additional facts referred to in this section in formal proceedings. Additionally, in these formal proceedings, the utility may agree to accept the most recent rate of return or operating ratio allowed a water or wastewater utility by the Commission in a fully-litigated water or wastewater utility rate case, but the agreement will not be binding on the Commission or any formal complainant.
(6) A water or wastewater utility with a gross revenue of less than $250,000 annually shall be considered a small water or wastewater utility for purposes of short-form rate filings.
(b) Operating ratio methodology.
(1) This ratemaking method develops a revenue requirement where little or no rate base exists. The operating ratio at present rates shall be calculated as a ratio of operating expenses to operating revenues, where the numerator shall include operations and maintenance expense, annual depreciation on noncontributed facilities, amortization of multiyear expenses and applicable taxes and the denominator shall consist of the utility's operating revenues at present rates.
(2) The appropriate target operating ratio in a particular case shall be determined by considering at least the following factors:
(i) The operating ratios of comparable water or wastewater utilities.
(ii) Coverage of actual hypothetical, or both, interest expense.
(iii) A comparison of the cost of service with the cost of service of similar companies which do not employ an operating ratio rate methodology.
(iv) Current market conditions, including price infla- tion.
(v) The quality of service and efficiency of operations.
(vi) The rate case history.
(vii) Whether there is any rate base and, if so, whether any depreciation expense is being claimed in the filing.
(viii) An acquisition adjustment, if any.
(ix) Financial resources.
(x) The fairness of the resulting return.
(3) An increase or decrease in operating revenues shall be determined by dividing the utility's reasonable and legitimate operating expenses by the target operating ratio determined in paragraph (2), and subtracting that amount from the test period operating revenues.
(4) The operating ratio methodology shall be available to water and wastewater utilities with annual gross revenues (excluding current year Contributions In Aid of Construction (CIAC)) of less than $250,000. If a water or wastewater utility wishes to employ an operating ratio methodology in calculating its rates, it shall make this request in the context of a rate case, and shall bear the burden of proving all necessary elements thereof.
(c) Purchased water cost adjustment--sliding scale of rates.
(1) A water utility with annual gross revenues of less than $250,000, may establish a sliding scale of rates under 66 Pa.C.S. § 1307 (relating to sliding scale of rates; adjustments) upon 60 days' notice to customers, to recover the cost of purchased water obtained from municipal authorities or entities which are not affiliated interests as defined in 66 Pa.C.S. § 2101 (relating to the definition of affiliated interest). The purchased water cost adjustment filing shall be accompanied with a tariff or tariff supplement which establishes the new rates to be placed into effect, a calculation showing the application of the new rate schedule to the company's average level of customer usage, an income statement demonstrating the effect of the tariff or tariff supplement upon the utility's revenues for the period in which the proposed tariffs would be in effect, a copy of the notice provided to customers and a verification that all customers have received notice of the proposed rate change.
(2) A purchased water cost adjustment shall be revised and refiled within 60 days of a decrease in purchased water costs, and shall be designed to pass through to customers the entire reduction in purchased water costs from the date the reduction becomes effective. A purchased water adjustment may be revised and refiled at any time after an increase in purchased water costs, and shall be designed to recover cost increases prospectively from the date of filing only.
(3) Within 30 days following the end of the calendar year, every public utility utilizing a purchased water cost adjustment shall file the report prescribed by 66 Pa.C.S. § 1307(e) for the preceding 1-year period ending December 31st. These reports shall be reviewed by the Commission's Bureau of Audits, and, if no complaint or objection is raised within 45 days after filing, either by the Commission's Bureau of Audits or another person, the reports shall be deemed approved.
(d) Emergency Maintenance and Operation Fund (EMOF).
(1) EMOF. An expense claim in lieu of a cash working capital claim which may be allowable in anticipation of emergencies such as extraordinary repairs and maintenance, drought conditions, extraordinary environmental and physical damages to sources of supply, floods, storms, freeze-ups, or other health and welfare-threatening situations. The burden of demonstrating that actual or proposed disbursements from the fund are reasonable and in the public interest shall be borne by the utility.
(2) Methodology. The Fund expense may not exceed 45 days of average operating expenses, excluding taxes and depreciation. If a claim for Fund expense is made, no additional claim for cash working capital shall be made or considered.
(3) Procedures. The amounts allocated for an EMOF shall be kept in a separate cash account and disbursements shall be restricted to the uses in paragraph (1). The utility shall report all disbursements from the Fund to the Commission within 10 days and shall provide a summary of each year's disbursements on its Annual Report. Disbursements from the Fund which are found by the Commission to have been made improperly, or in violation of a statute, regulation or order of the Commission or other Commonwealth agency shall be returned to the account or be refunded to ratepayers as the Commission may direct. A person or individual who makes, authorizes or directs disbursement from a Fund which is improper or in violation of any statute, regulation or order of the Commission shall be subject to 66 Pa.C.S. § 3301 or § 3301 (relating to civil penalties for violations); and criminal penalties for violations).
(4) Availability. The Commission may authorize funding a Fund for water and wastewater utilities with annual gross revenues (excluding current year CIAC) of less than $250,000.
(e) Reserve account
(1) Reserve account. A segregated account to be funded by customer contributions collected through base rates for the purpose of making capital improvements to utility plant pursuant to a long-range plan developed in conjunction with the Commission or the Department of Environmental Protection, or as required to assure compliance with State or Federal safe drinking water statutes or regulations. The burden of demonstrating that actual or proposed expenditures are reasonable and in the public interest shall be borne by the utility.
(2) Procedures. The amounts to be allocated to the reserve account will be determined by the Commission after review of the utility's proposed capital budget and the justification for that budget. Funds in the reserve account shall be kept in a separate interest bearing cash account. Interest accrued shall be credited to the reserve account and shall become part of the corpus of the reserve account. Funds from the account shall not be employed for a purpose other than those permitted under this section. Disbursements from the fund shall not be made without written authorization by the Commission upon petition, shall be restricted to the uses in subsection (d)(1), and shall be made in accordance with a capital budget submitted with the initial rate filing or as modified with the consent of the Commission. In proposing any modifications of the capital budget, the Commission or a party may solicit the advice or testimony of the Department of Environmental Protection. The utility shall report all disbursements from the reserve account by written notice to the Commission and to other persons as the Commission may direct. Disbursements from the reserve account which are found by the Commission to have been made improperly, or in violation of any statute, regulation or order of the Commission or other Commonwealth agency shall be returned to the account or be refunded to ratepayers as the Commission may direct. A person who makes, authorizes or directs a disbursement from a reserve account without authorization by the Commission in accordance with these rules shall be subject to 66 Pa.C.S. § 3301 or § 3302.
(3) Accounting. Plant capitalized by means of the Reserve Account shall be accounted for as a contribution in aid of construction.
(4) Availability. The Commission may authorize funding of a reserve account for water and sewage utilities with annual gross revenues (excluding current year CIAC) of less than $250,000.
[Pa.B. Doc. No. 97-78. Filed for public inspection January 17, 1997, 9:00 a.m.] _______
5The distinction between a rate base and an expense claim is directly related to the expected duration of the service life of the item acquired. Capital assets, that is, plant or other expenditures with a service life in excess of 1 year, are generally considered to be includible in rate base, may serve as the basis of a return by the utility, and are depreciable over time. Noncapital expenditures constitute expenses for ratemaking purposes, and the ratemaking process establishes a test year for the purpose of analyzing all such expenses to establish a ''normal'' annual expense claim. Expenses may not serve as the basis for a utility return.
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