People v. Illinois Commerce Commission

ILLINOIS OFFICIAL REPORTS

Appellate Court

People ex rel. Madigan v. Illinois Commerce Comm’n, 2011 IL App (1st) 100654

Appellate Court THE PEOPLE ex rel. LISA MADIGAN, Attorney General of the State

Caption of Illinois, Petitioner, v. ILLINOIS COMMERCE COMMISSION;

NORTH SHORE GAS COMPANY, PEOPLES GAS LIGHT & COKE

COMPANY; VANGUARD ENERGY SERVICES, LLC; PRAIRIE

POINT ENERGY, LLC d/b/a Nicor Advanced Energy LLC; UNITED

WORKERS UNION OF AMERICA, AFL-CIO, LOCAL NO. 18007;

CONSTELLATION NEW ENERGY, INC., Gas Division; CITIZENS

UTILITY BOARD; THE CITY OF CHICAGO; and RETAIL GAS

SUPPLIERS, Respondents.

District & No. First District, Fifth Division

Docket Nos. 1-10-0654, 1-10-0655, 1-10-0936, 1-10-1790, 1-10-1846,

1-10-1852 cons.

Filed September 30, 2011

Held In proceedings before the Illinois Commerce Commission on the action

(Note: This syllabus of two gas utilities to restructure residential gas rates and gain approval

constitutes no part of of a special rider for infrastructure improvements, the Commission

the opinion of the court abused its discretion in approving the rider because the rider constituted

but has been prepared single-issue ratemaking without a showing of special circumstances to

by the Reporter of provide adequate justification, but the Commission’s determination of the

Decisions for the utilities’ operating expenses and rate base would not be disturbed, the

convenience of the Commission did not err in excluding prudent and reasonable pension

reader.)

costs from the rate base, and the Commission did not err in making an

adjustment to the utilities’ return on equity.

Decision Under Petition for review of orders of Illinois Commerce Commission.

Review

Judgment Affirmed in part and reversed in part; cause remanded.

Counsel on Kristin Munsch and Christie R. Hicks, both of Citizens Utility Board, and

Appeal Lisa Madigan, Attorney General (Michael A. Scodro, Solicitor General,

and Paul Berks, Janice A. Dale, and Karen L. Lusson, Assistant Attorneys

General, of counsel), both of Chicago, for petitioners.

John P. Ratnaswamy and Carla Scarsella, both of Rooney Rippie &

Ratnaswamy LLP, Mary Klyasheff, of Integrys Energy Group, Inc., and

Theodore Eidukas, of Foley & Lardner LLP, all of Chicago, and Bradley

D. Jackson, of Foley & Lardner LLP, of Madison, Wisconsin, for

respondents North Shore Gas Company and Peoples Gas Light & Coke

Company.

John P. Kelliher and James E. Weging, Special Assistant Attorneys

General, of Chicago, for respondent Illinois Commerce Commission.

Panel JUSTICE HOWSE delivered the judgment of the court, with opinion.

Presiding Justice Epstein and Justice J. Gordon concurred in the

judgment and opinion.

OPINION

¶1 This consolidated appeal arises from the filing of an action by North Shore Gas Company

(North Shore) and Peoples Gas Light and Coke Company (Peoples Gas) (together referred

to as the Utilities) with the Illinois Commerce Commission (Commission), which sought to

restructure the rates the gas utility companies charged residential customers for the delivery

of natural gas and approve a special rider for infrastructure improvements to the utilities’ gas

delivery system. The Commission entered its final order on January 22, 2010, and a

subsequent order on rehearing on June 2, 2010. Several parties involved in the proceedings

objected to certain aspects of the Commission’s final order and filed appeals, which have

been consolidated into the present action before this court.

¶2 For the reasons that follow, we affirm the Commission’s order in part, reverse in part,

and remand the cause for further proceedings consistent with this opinion.

-2-

¶3 BACKGROUND

¶4 On February 25, 2009, North Shore and Peoples Gas each filed tariffs with the

Commission that consisted of a proposed general increase in natural gas distribution rates,

certain new tariff riders, and other tariff revisions. The tariff requests were supported by

“prefiled” direct testimony and other material. On March 25 and July 8, 2009, the

Commission suspended the proposed rates and initiated contested rate cases to examine the

proposed rates and revisions. Several parties intervened, including the parties to this appeal,

and an evidentiary hearing was held.

¶5 The Commission entered its final dispositive order on January 21, 2010, permanently

cancelling previous gas rates and ordering the filing of new tariff sheets. In doing so, the

Commission authorized Peoples Gas to file new tariff sheets designed to produce annual

revenues of $530,633,000, which represented a gross increase of $69,803,000; and North

Shore to file new tariff sheets to produce annual revenues of $79,067,000, which represented

a gross increase of $13,867,000. The Commission determined the “just and reasonable”

return which Peoples Gas should be allowed to earn on its net original cost rate base is

8.05%, which incorporated a return on common equity of 10.23% and costs of long-term

debt of 5.28% with a just and reasonable capital structure of 56% common equity and 44%

long-term debt. North Shore’s rate of return was set at 8.19%, which incorporated a return

on common equity of 10.33% and costs of long-term debt of 5.48% with a just and

reasonable capital structure of 56% common equity and 44% long-term debt. In calculating

those rates, the Commission denied the gas utilities recovery of certain employee incentive

compensation and pension costs. The Commission also approved an “Infrastructure Cost

Recovery Rider” (Rider ICR) proposed by Peoples Gas, which consisted of a monthly

surcharge on customer bills designed to allow Peoples Gas to recover costs associated with

replacing certain additional cast iron and ductile iron gas mains and connecting facilities.

¶6 Several parties, including the State of Illinois (the People), the Citizens Utility Board (the

CUB) and the Utilities, filed timely applications for rehearing. The Commission granted

rehearing to the People and the CUB solely on the limited issue of whether Rider ICR’s

“baseline” was improperly set. The Commission denied all of the other parties’ applications

for rehearing. The Commission ultimately approved the Rider ICR baseline that was agreed

to by its staff (hereinafter, staff) and Peoples Gas, making only small changes to Rider ICR’s

audit provisions in its revised order. Several parties filed separate appeals from the

Commission’s final order, which have been consolidated into the present action pending

before this court.

¶7 ANALYSIS

¶8 I. Standard of Review

¶9 It is well settled that we are required to give substantial deference to the Commission’s

decisions, in light of its expertise and experience in this area. Commonwealth Edison Co. v.

Illinois Commerce Comm’n, 398 Ill. App. 3d 510, 514 (2009); Alhambra-Grantfork

Telephone Co. v. Illinois Commerce Comm’n, 358 Ill. App. 3d 818, 821 (2005). The

-3-

Commission’s “findings of fact are to be considered prima facie true; its orders are

considered prima facie reasonable; and the burden of proof on all issues raised in an appeal

is on the appellant.” United Cities Gas Co. v. Illinois Commerce Comm’n, 163 Ill. 2d 1, 11

(1994). Such deference is “especially appropriate in the area of fixing rates.” Iowa-Illinois

Gas & Electric Co. v. Illinois Commerce Comm’n, 19 Ill. 2d 436, 442 (1960). Therefore, our

review is generally limited to the following matters: (1) whether the Commission acted

within its authority; (2) whether it made adequate findings to support its decision; (3)

whether the decision was supported by substantial evidence; and (4) whether state or federal

constitutional rights were infringed. Commonwealth Edison Co., 398 Ill. App. 3d at 514

(citing Commonwealth Edison Co. v. Illinois Commerce Comm’n, 322 Ill. App. 3d 846, 849

(2001)). We will not reevaluate the credibility or weight of the evidence, nor substitute our

judgment for that of the Commission. Commonwealth Edison Co., 398 Ill. App. 3d at 514.

¶ 10 II. The People’s and the CUB’s Appeal

¶ 11 Both the People and the CUB appeal from the Commission’s decision to approve Rider

ICR. The People and CUB contend the Commission abused its discretion by allowing

Peoples Gas to recoup what amount to discretionary infrastructure investments through a

rider. Specifically, the People and the CUB contend the Commission misunderstood the legal

standard that governs its authority to engage in “single issue rulemaking” through a rider.

The People and the CUB also contend the record lacks substantial evidence to support the

extraordinary rate recovery mechanism of a rider in this case.

¶ 12 The evidence adduced below established Peoples Gas’ service territory covers an area

of about 237 square miles with a population of approximately 3 million people, serviced by

4,025 miles of gas distribution mains. At the time of the Commission proceeding,

approximately half of Peoples Gas’ distribution main system was still comprised of cast iron

and ductile iron gas mains, which are only able to provide low-pressure gas service. Peoples

Gas presented evidence that these aging cast iron ductile iron mains require a higher level

of risk management, generate a larger number of leaks and cause a larger number of service

outages than modern mains made from polyethylene pipe material would cause.

¶ 13 In 1981, Peoples Gas decided to begin replacing its outdated main system. Peoples Gas

estimated the replacement program would not be completed until sometime between 2050

and 2080. Under the current replacement program, Peoples Gas had successfully replaced

1,568 of 4,031 miles of old mains, with an average replacement rate of 45 miles per year

through 2008. However, the average annual replacement rate of 45 miles had dropped to 20

miles for 2009 and an estimated 10 miles for 2010 due to the “harsh economic climate,”

which caused Peoples Gas to decide to preserve its capital rather than expend it on an

accelerated main replacement program.

¶ 14 Peoples Gas first sought an infrastructure cost recovery rider in a previous rate case filed

in 2007; however, the Commission rejected the request. Although the Commission

determined it was within its discretionary powers to authorize the rider, it noted Peoples Gas

had failed to establish there was a “need” for such a rider. The Commission’s final decision

filed on March 25, 2009, identified six standards Peoples Gas had to demonstrate in order

-4-

for the Commission to find there is a need for an infrastructure cost recovery rider: (1) a

detailed description and cost analysis of the proposed system modernization; (2) an

identification, evaluation and justification of the technology involved; (3) a detailed

identification and description of the improved functionalities of the modernized system both

for the company and for customers; (4) an analysis of the benefits of the system

modernization in terms of reduced operating and maintenance costs, enhanced system safety,

improved customer safety and reliability, reduced greenhouse gas emissions and increased

options for energy efficient appliances, new products and services; (5) an analysis of

regulatory mechanisms to allow companies to both recover their costs of system

modernization as well as to flow reduced system costs back to customers; and (6) an

identification and analysis of legal and regulatory barriers to the implementation of system

modernization.

¶ 15 In the rate case at issue here, Peoples Gas again sought an infrastructure cost recovery

rider through Rider ICR. Peoples Gas argued the rider did not violate the rule against single-

issue ratemaking because it merely facilitates the direct recovery of particular costs in a

manner that either has no direct impact on or accounts for any corresponding changes to the

components underlying the utility’s rate of return so that there is no under or over recovery.

In support of its position, Peoples Gas noted the proposed rider included a factor for

offsetting any savings generated by the accelerated program, thus preventing any

overstatement of the utility’s overall revenue requirements by Ride ICR. Peoples Gas also

noted the rider had been modified, at the Staff’s suggestion, to require re-calculation of the

savings factor no less than every three years, with the Commission and other parties retaining

the right to initiate proceedings to do so more frequently if deemed necessary.

¶ 16 In support of Rider ICR, Peoples Gas also presented a substantial amount of expert

testimony regarding the cost analysis and benefits the improved functionality of the new

system would provide to the utility and its customers. Specifically, Peoples Gas provided

testimony from Salvatore Marano, a licensed professional engineer, indicating that system

modernization would provide several benefits to customers, including enhanced system

safety, reduced system costs, potential new products and significant environmental benefits.

Marano testified that the new distribution system would provide substantial savings to

Peoples Gas’ ongoing operations and maintenance costs by reducing the number of leak

repairs and safety inspections the utility had to conduct, which would generate a total of $244

million in cost savings. Marano also estimated Peoples Gas’ net construction cost savings

from accelerating the main replacement program construction through the use of the rider

would be $273 million.

¶ 17 Marano further noted that an additional benefit to the City of Chicago (the City) and its

residents of accelerating the main replacement program through the use of a rider would be

the creation of a substantial number of jobs in the community. Peoples Gas’ witness James

Schott explained a rider would allow the Utility to proceed with an accelerated main

replacement program much more quickly, without the financial uncertainty that accompanies

having to wait until the next rate case to recover costs associated with modernizing the

system.

¶ 18 The Union representing Peoples Gas’ employees who work on the mains on a daily basis

-5-

and the City of Chicago also intervened in support of Rider ICR. Although the City

recognized Peoples Gas’ expert witnesses had not testified the current gas main system was

unsafe or in immediate danger, the City noted the magnitude of potential safety issues

presented by the antiquated system supported replacing the system as expeditiously as

reasonably possible. While the City noted the increased use of riders by utilities threatens

effective and thorough regulation of monopoly services, the City argued replacing the old

mains as expeditiously as reasonable to ensure public safety presented an extraordinary

situation justifying the use of a rider.

¶ 19 The People, the CUB and the Commission’s Staff objected to Rider ICR. The People

argued the proposed rider should be rejected by the Commission because it constituted

improper single-issue ratemaking. The People noted that instead of considering costs and

earnings in the aggregate, where potential changes in one or more items of expense or

revenue may be offset by increases and decreases in other such items, the Rider ICR proposal

only considered changes in infrastructure investment in isolation–ignoring the totality of

circumstances. The People noted the capital costs associated with an accelerated main

replacement were neither “unexpected, volatile or fluctuating expenses”; nor were the costs

authorized by statute.

¶ 20 The People also noted that Peoples Gas had refused to commit to a specific accelerated

main replacement plan, that Peoples Gas would not commit to any certain start date on

acceleration, and that Peoples Gas would retain control over the schedule of acceleration.

The People argued the 2030 completion date Marano testified to was both impractical and

unrealistic as a timeline for main replacement. The People also argued Marano’s 2030

completion date for main replacement would cost ratepayers over $3 billion more than

Peoples Gas’ existing 2059 completion date.

¶ 21 Although the CUB did not specifically address the operational need for an accelerated

modernization program, it also argued the rider should be rejected given the legal

proscriptions against single-issue ratemaking. In support, the People and the CUB’s expert

witness, Scott Rubin, noted Peoples Gas had failed to show that the existence or absence of

Rider ICR would affect its cost of capital, impact its capability to finance necessary

improvements, or jeopardize its ability to provide safe and reliable service. The People and

the CUB argued Peoples Gas’ own historical rate of main replacement investment suggested

Rider ICR is simply not needed.

¶ 22 The Staff also argued to the Commission that Rider ICR should be rejected. Although

the Staff recognized the Commission has the discretion to approve riders in proper cases as

an alternative to the traditional approach of setting rates, the Staff argued Peoples Gas had

failed to provide adequate justification for Rider ICR. Although Peoples Gas presented

expert testimony that the proposed rider was consistent with the points raised by the Staff and

the six standards outlined by the Commission in the last rate case, the Staff’s witness

explained the Staff’s primary position in the previous case was to reject the proposed rider

because the need and justification for rider recovery had not been established. The Staff

noted the need for an accelerated infrastructure replacement program and the cost recovery

mechanism for such a program are two different issues. While the Staff recognized Marano’s

testimony addressed the need for an accelerated program to replace the current network of

-6-

cast iron and ductile iron mains, the Staff noted Marano’s testimony did not explain why the

use of a rider mechanism to recover costs for that goal would be justified over traditional

recovery through base rates.

¶ 23 The Staff’s expert witnesses, Sheena Knight-Garlisch and Peter Lazare, both agreed

Peoples Gas had not adequately explained why traditional rate case fillings would not allow

a prompt and fair rate recovery for the costs associated with modernizing the system. The

Staff’s witnesses also noted Peoples Gas is seeking funding for an accelerated replacement

program that has yet to be developed, which makes it difficult to assess the need for a special

recovery mechanism without knowing the Utility’s funding needs.

¶ 24 The Commission determined the rule against single-issue ratemaking was not a bar to its

adoption of Rider ICR. The Commission also determined the Utility’s proposed rider

complied with the six standards it had outlined in the earlier rate case. Accordingly, the

Commission exercised its legal authority to approve Rider ICR. However, the Commission

adopted several of the Staff’s recommendations intended to ensure proper regulatory

oversight and implementation of the rider.

¶ 25 In reaching its conclusion, the Commission stated “[i]mmediate safety concerns are not

what drive our concern.” However, the Commission highlighted a more accelerated approach

to upgrading the system is needed to prevent or mitigate a foreseeable future risk of system

failure, and noted that “accelerated system improvement has become for the Commission a

matter of the public interest more so than just a Company proposal.” Although the

Commission recognized section 8-503 of the Public Utilities Act (Act) (220 ILCS 5/8-503

(West 2008)) would authorize it to require Peoples Gas to undertake and accelerated main

replacement program through traditional ratemaking procedures, the Commission noted that

to pursue such an action would require it to initiate a new formal proceeding and employ all

of its traditional processes to arrive at a decision. Because a burdensome and time-consuming

series of rate cases would likely be needed to implement an accelerated program under

section 8-503, the Commission held it could exercise its discretionary authority in the most

prudent manner by approving Rider ICR.

¶ 26 The amount a utility is permitted to recover from its customers in the rates it charges is

determined by its revenue requirement. City of Chicago v. Illinois Commerce Comm’n, 281

Ill. App. 3d 617, 627 (1996). “A company’s revenue requirement is the sum of a company’s

operating costs and the rate of return on its invested capital.” City of Chicago, 281 Ill. App.

3d at 627 (citing Citizens Utilities Co. of Illinois v. Illinois Commerce Comm’n, 124 Ill. 2d

195, 201 (1988)). Therefore, ratemaking considers costs and earnings in the aggregate

because potential changes in one or more items might be offset by changes in other items.

City of Chicago, 281 Ill. App. 3d at 627 (citing A. Finkl & Sons Co. v. Illinois Commerce

Comm’n, 250 Ill. App. 3d 317, 325 (1993) (Finkl)).

¶ 27 Single-issue ratemaking is prohibited because it considers changes in particular portions

of a utility’s revenue requirement in isolation, which ignores potentially offsetting

considerations and risks understating or overstating the overall revenue requirement.

Business & Professional People for the Public Interest v. Illinois Commerce Comm’n, 146

Ill. 2d 175, 244 (1991) (BPI). However, a rider can change a rate without requiring the utility

-7-

to delay recovery until it files a general rate case. Citizens Utility Board v. Illinois Commerce

Comm’n, 166 Ill. 2d 111, 133 (1995).

¶ 28 Our supreme court has recognized a rider mechanism:

“merely facilitates direct recovery of a particular cost, without direct impact on the

utility’s rate of return. The prohibition against single-issue ratemaking requires that,

in a general base rate proceeding, the Commission must examine all elements of the

revenue requirement formula to determine the interaction and overall impact any

change will have on the utility’s revenue requirement, including its return on

investment.” Citizens Utility Board, 166 Ill. 2d at 138.

¶ 29 Our supreme court has also recognized that the single-issue rule “does not circumscribe

the Commission’s ability to approve direct recovery of unique costs through a rider when

circumstances warrant such treatment.” Citizens Utility Board, 166 Ill. 2d at 138. Because

the Commission has the power to authorize riders in a proper case, such authorization will

not be reversed absent an abuse of discretion. City of Chicago, 281 Ill. App. 3d at 627.

¶ 30 In Finkl, the Commission approved a rider so the utility could recover costs associated

with certain demand-side management programs. The Commission found the rider was the

most appropriate method of recovery of the costs, noting “the actual expenses are difficult

to predict in advance, especially given the fact that neither the Commission nor [the utility]

has extensive experience in the implementation of [demand-side] analysis and programs, and

may fluctuate from year to year and from month to month.” (Internal quotation marks

omitted.) Finkl, 250 Ill. App. 3d at 322. This court reversed, holding the rider violated the

prohibition against single-issue ratemaking. Finkl, 250 Ill. App. 3d at 326. Although the

court recognized riders are “useful in alleviating the burden imposed upon a utility in

meeting unexpected, volatile or fluctuating expenses,” the court noted the costs involved in

the approved rider revealed “no greater potential for unexpected, volatile or fluctuating

expenses which [the utility] cannot control, than costs incurred in estimating base

ratemaking.” (Emphasis in original.) Finkl, 250 Ill. App. 3d at 327.

¶ 31 In Citizens Utility Board, the CUB contended the utility’s use of a rider to recover coal-

tar cleanup costs allowed the Commission to approve cost recovery without considering

other elements of the revenue requirement formula, ignoring the possibility that a rate

increase may not be necessary. In approving the coal-tar cleanup rider at issue, the

Commission noted that, given the wide variations and the difficulties in forecasting the costs

of investigation and remediation activities, a rider could be expected to provide a more

accurate and efficient means of tracking and matching costs with recoveries than would base

rate recovery methods. Citizens Utility Board, 166 Ill. 2d at 138-39. Numerous witnesses

testified to the uncertain and variable nature of the expenses for coal-tar cleanup. Id. at 139.

Accordingly, our supreme court found that the proposed recovery through a rider mechanism,

outside the context of a traditional rate proceeding, did not violate the prohibition against

single-issue ratemaking. Id.

¶ 32 In City of Chicago, we recognized a rider is appropriate for recovering fluctuating costs;

however, we rejected the proposition that only unexpected, volatile or fluctuating expenses

are properly recovered through a rider. City of Chicago, 281 Ill. App. 3d at 628 (citing

-8-

Citizens Utility Board, 166 Ill. 2d at 138-39). The Commission approved the use of a rider

in order for the utility to recover its franchise-type fees and costs. Although this court

recognized riders should be closely scrutinized because of the danger of single-issue

ratemaking, we found such a danger was not present in the case before us. City of Chicago,

281 Ill. App. 3d at 628-29. The court held the “proposed restructuring was exactly that–a

reallocation which did not have any impact whatsoever on [the utility’s] overall revenue

requirement.” Id. at 629. The court noted the franchise fees were already included in the

utility’s overall rate structure; the Commission’s order simply redistributed them. Id.

“Because the rider here ‘merely facilitates direct recovery of a particular cost, without direct

impact on the utility’s rate of return’ (Citizens Utility Board, 166 Ill. 2d at 138, 651 N.E.2d

at 1102), it was not an abuse of discretion for the Commission to use it as the mechanism of

cost recovery.” Id.

¶ 33 By contrast, in Commonwealth Edison Co., 405 Ill. App. 3d at 414-15, appeal denied,

No. 111548, 949 N.E.2d 657 (Ill. Mar. 30, 2011) (table), the Second District considered the

People’s and the CUB’s contentions that a Commission-approved provision known as “Rider

SMP” was contrary to settled ratemaking principles and not justified by the evidence.

ComEd, the utility, proposed Rider SMP, which consisted of a “system modernization

project” charge to customers, in order to immediately recoup the costs of modernizing its

electricity delivery system toward a “smart grid.” In support of the rider, ComEd presented

testimony that a smart grid would achieve cost savings and improve efficiency by phasing

out 675 full-time meter readers and supervisor positions, eliminating meter reading

equipment, improving bill collections, reducing billing errors and disconnecting nonpaying

customers more efficiently. ComEd argued to the Commission that Rider SMP would give

customers the benefits of the smart grid technology earlier than might otherwise occur,

because ComEd could not afford the project without the rider.

¶ 34 The court recognized that because a rider, by nature, is a method of single-issue

ratemaking, it is not allowed absent a showing of exceptional circumstances. Commonwealth

Edison Co., 405 Ill. App. 3d at 415 (citing Finkl, 250 Ill. App. 3d at 327). After analyzing

the prior decisions in Finkl, City of Chicago and Citizens Utility Board, the Second District

gleaned a guiding principle for testing a rider’s validity:

“[T]he Commission has discretion to approve a utility’s proposed rider mechanism

to recover a particular cost if (1) the cost is imposed upon the utility by an external

circumstance over which the utility has no control and (2) the cost does not affect the

utility’s revenue requirement. In other words, a rider is appropriate only if the utility

cannot influence the cost [citation] and the expense is a pass-through item that does

not change other expenses or increase income [citation].” Id. at 414 (citing Citizens

Utility Board, 166 Ill. 2d at 138).

¶ 35 The court held its test reconciled the approval of diverse riders, including: “(1) a rider to

recoup increases in the wholesale cost of natural gas, *** [citation]; (2) a rider to recoup

expenses for government-mandated environmental remediation [citations]; and (3) a rider

to recoup a franchise fee that a municipality charges the utility [citation].” Id. (citing Citizens

Utility Board, 166 Ill. 2d at 138-39, City of Chicago v. Illinois Commerce Comm’n, 13 Ill.

2d 607, 614 (1958), and City of Chicago, 281 Ill. App. 3d at 628-29). The court recognized

-9-

that in each instance noted above, the expense included in the rider was an externality

imposed on the utility, and, therefore, the expense was properly passed directly on to the

consumer through a rider without affecting the utility’s actual return on investment. Id. The

Second District also noted its test explained the rejection of the rider in Finkl for demand-

side management expenses, where this court held the rider was invalid because the expenses

were something completely within the utility’s control. Id. (citing Finkl, 250 Ill. App. 3d at

326).

¶ 36 The court held Rider SMP did not meet its criteria to warrant appropriate single-issue

ratemaking because: (1) the expenses related to upgrading to smart grid technology were not

“unexpected, volatile, or fluctuating,” as ComEd alone dictated the program’s scope and,

therefore, its costs; (2) the capital costs associated with the upgrades were not the result of

a legislative mandate but rather were the result of ComEd’s decision to renovate to reduce

other costs; (3) ComEd can cover the expenses by a fiscal and operational plan that is

completely within the utility’s control; and (4) the Commission heard no evidence that the

system modernization costs might produce unacceptable financial outcomes if not afforded

special treatment. Commonwealth Edison Co., 405 Ill. App. 3d at 414-15. Precisely because

the improvements covered by Rider SMP were expected to reduce other expenses and

increase income in the long term, which would affect the utility’s revenue requirement, the

court held to allow Rider SMP would be to improperly consider in isolation changes in a

particular portion of a utility’s revenue requirement. Id. at 415 (citing BPI, 146 Ill. 2d at

244). Accordingly, the court concluded that the Commission abused its discretion and

reversed Rider SMP, finding the rider constituted improper single-issue ratemaking that was

not justified by any special circumstances. Id. In support, the court noted “[t]he evidence

showed that ComEd historically has invested in capital distribution improvements and

recouped those costs through traditional ratemaking procedures, and the system

modernization program should be treated no differently.” Id.

¶ 37 In this case, Peoples Gas and the Commission stress the real issue is whether the cost

recovery mechanism facilitates cost recovery without directly impacting the utility’s rate of

return. See Citizens Utility Board, 166 Ill. 2d at 138. The Commission notes that by

removing the cost of the modernization from base rates and recovering it on a dollar-by-

dollar basis through a rider, the remaining base rates, together with the costs recovered

through rider, are still designed to generate enough revenue to allow the utility to pay its bills

and obtain the same rate of return as established in the rate case. The Commission suggests

this evidences the fact that the rider would not impact Peoples Gas’ rate of return. If Rider

ICR was simply a reallocation of costs that had no direct impact on the utility’s rate of return,

the Commission would not have abused its discretion in approving the rider. See City of

Chicago, 281 Ill. App. 3d at 628-29 (“Because the rider here ‘merely facilitates direct

recovery of a particular cost, without direct impact on the utility’s rate of return’ (Citizens

Utility Board, 166 Ill. 2d at 138, 651 N.E.2d at 1102), it was not an abuse of discretion for

the Commission to use it as a mechanism of cost recovery.”).

¶ 38 The People and the CUB counter that the costs covered by Rider ICR do impact the

utility’s rate of return. Specifically, the People and the CUB note the evidence in the record

establishes that over a 49-year period, Rider ICR would increase Peoples Gas’ revenue

-10-

requirement substantially. The People argue that any increase in the revenue requirement

“creates a proportional increase in the return on that investment” (see Citizens Utility Board,

166 Ill. 2d at 137), which in turn would have a direct impact on the utility’s rate of return.

¶ 39 We note the record reflects that a witness for the People and the CUB, Mr. Rubin,

testified the net effect Rider ICR would have on Peoples Gas’ revenue requirement would

be to increase it by $3 billion over what it would have been under the existing main

replacement program. However, Peoples Gas notes that Mr. Rubin admitted on cross-

examination that if his analysis was carried out until the capital investments were completely

depreciated for both programs, Peoples Gas’ current main replacement program would in fact

generate an overall larger revenue requirement than the accelerated main replacement

program would.

¶ 40 In light of Commonwealth Edison Co, we find Rider ICR does not meet the criteria

necessary to warrant appropriate single-issue ratemaking. Similar to Rider SMP, the rider at

issue here does not include recovery of costs that are necessarily “unexpected, volatile, or

fluctuating,” as Peoples Gas alone dictates the program’s scope and, therefore, its ultimate

cost. Rider ICR is also not intended to recoup expenses for government-mandated

environmental remediation; nor are the costs the result of a legislative mandate. Instead, the

costs covered by Rider ICR are for capital improvements to Peoples Gas’ natural gas delivery

system that are likely to have a direct impact on the utility’s actual rate of return.

¶ 41 Moreover, similar to Rider SMP, the Staff witnesses’ testimony below suggests the costs

associated with an accelerated main replacement program under Rider ICR could be

recovered through traditional ratemaking procedures. As the People’s expert witness noted,

Peoples Gas’ own historical rate of main replacement investment indicates the costs

associated with the improvements were previously able to be recovered through traditional

rate cases, without the need to resort to a special rider cost recovery mechanism. Although

the Staff’s expert witnesses conceded below that acceleration of the main replacement

program was in the public’s best interests, the Staff’s evidence also indicated that traditional

ratemaking procedures provide an acceptable avenue to pursue such a goal without requiring

the use of a rider. In fact, the Commission’s order itself specifically notes the Commission

could have required Peoples Gas to undertake an accelerated main replacement program

under section 8-503 of the Act while utilizing traditional ratemaking procedures. While

traditional ratemaking procedures may constitute a burdensome and time-consuming process

in the Commission’s eyes, a desire to streamline that legislatively created process alone does

not constitute a showing of the type exceptional circumstances necessary to justify the use

of a rider. See Commonwealth Edison Co., 405 Ill. App. 3d at 415 (citing Finkl, 250 Ill. App.

3d at 327).

¶ 42 Accordingly, under the standards set out by the Second District in Commonwealth Edison

Co., we find the Commission abused its discretion in approving Rider ICR because the rider

constituted single-issue ratemaking that was not adequately justified by any special

circumstances. See Commonwealth Edison Co., 405 Ill. App. 3d at 415 (“The evidence

showed that ComEd historically has invested in capital distribution improvements and

recouped those costs through traditional ratemaking procedures, and the system

modernization program should be treated no differently.”).

-11-

¶ 43 III. The Utilities’ Appeal

¶ 44 The Utilities contend the Commission erred in determining the Utilities’ operating

expenses and rate base. Specifically, the Utilities contend the Commission committed

reversible error by: (1) denying the Utilities the full recovery of their prudent and reasonable

employee incentive compensation costs; (2) calculating the Utilities’ costs of capital by

making unwarranted and duplicative reductions in the Utilities’ approved rate of return on

common equity; and (3) denying Peoples Gas the full recovery of its prudent and reasonable

pension costs. Each of the alleged errors is addressed in turn below.

¶ 45 A. Incentive Compensation Costs

¶ 46 The Utilities contend the Commission erred by disallowing almost all of the Utilities’

prudent and reasonable employee incentive compensation costs. Specifically, the Utilities

contend the Commission erred by: (1) unlawfully disallowing the Utilities’ employee

incentive compensation costs despite uncontradicted evidence of, and no dispute regarding,

the prudence and reasonableness of the costs; (2) applying an invalid Commission-created

direct customer benefits standard that improperly disallowed prudent and reasonable

incentive compensation costs; and (3) applying a standard that arbitrarily and capriciously

picked what customer benefits count to allow cost recovery while disregarding other

customer benefits.

¶ 47 Here, the Utilities’ primary witness regrading employee incentive compensation costs,

James Hoover, testified that the Utilities design their total cash compensation packages at

market median based on data collected from other energy service companies, that the

Utilities design their total compensation programs, including their incentive compensation

programs, in order to attract and retain a sufficient, qualified and motivated work force, and

that attracting and retaining such a work force benefits customers by making sure there are

enough workers to perform needed work, by maintaining and improving the quality of work

and by reducing the expenses associated with recruiting and retaining new employees.

Hoover also testified the employee stock plans were an important part of the overall

compensation package that was designed to help attract and retain a qualified and motivated

work force.

¶ 48 The Commission ultimately agreed with the Staff’s recommendation that incentive

compensation that was related to financial goals, affiliate goals or shareholder goals should

not be recoverable from ratepayers. The Commission found Hoover’s testimony did not

“demonstrate a sufficient nexus between the expense and customer benefit.” The

Commission agreed with the People’s witness that when incentive compensation seeks to

achieve goals that primarily benefit shareholders, then it is reasonable to require that

shareholders bear the cost of that incentive compensation. The Commission concluded

attracting good employees is too remote a benefit for ratepayers to support recovery.

¶ 49 Illinois courts have recognized costs are generally recoverable from ratepayers if the costs

are reasonable and prudent. BPI, 146 Ill. 2d at 247. Generally, reasonable and prudent

expenditures for salaries should also be included in the rate base. Villages of Milford v.

-12-

Illinois Commerce Comm’n, 20 Ill. 2d 556, 566 (1960). The Utilities contend the “reasonable

and prudent” standard is the only standard they had to satisfy in order for the employee

incentive compensation costs to be included in its rate base, citing Citizens Utility Board,

166 Ill. 2d at 121 (“In setting rates, the Commission must determine that the rates accurately

reflect the cost of service delivery and must allow the utility to recover costs prudently and

reasonably incurred.”).

¶ 50 Moreover, the Utilities note that none of the Staff’s or the People’s witnesses challenged

Hoover’s testimony that the Utilities’ employee incentive costs were reasonable and prudent,

and that the costs benefitted customers. The Utilities contend “[w]here the testimony of a

witness is neither contradicted, either by positive testimony or by circumstances, nor

inherently improbable, and the witness has not been impeached, that testimony cannot be

disregarded by the trier of fact.” Bazydlo v. Volant, 164 Ill. 2d 207, 215 (1995).

¶ 51 Contrary to the Utilities’ contention, we find Illinois law supports the Commission’s use

of a direct benefit standard in denying 90% of Peoples Gas’ and 93% of North Shore’s

employee incentive compensation costs.

¶ 52 In Commonwealth Edison Co. v. Illinois Commerce Comm’n, 398 Ill. App. 3d 510

(2009), appeal denied, 237 Ill. 2d 554 (2010), the Commission ruled that the utility, ComEd,

did not demonstrate a sufficient nexus between the earnings-per-share portion of the

employee incentive compensation plan and a benefit to ratepayers. In affirming the

Commission’s decision, the court noted that although reasonable and prudent expenditures

for salaries are generally included in the rate base, under certain circumstances it has been

held that the cost of salaries should be apportioned between shareholders and ratepayers.

Commonwealth Edison Co., 398 Ill. App. 3d at 517 (citing Du Page Utility Co. v. Illinois

Commerce Comm’n, 47 Ill. 2d 550, 560-61 (1971), Villages of Milford, 20 Ill. 2d at 566, and

Candlewick Lake Utilities Co. v. Illinois Commerce Comm’n, 122 Ill. App. 3d 219, 226

(1983)). Accordingly, the court noted there is “ample precedent making a benefit to

ratepayers a condition upon which the recovery of salary-related expense depends.”

Commonwealth Edison Co., 398 Ill. App. 3d at 517. Moreover, the court noted the Act itself

makes room for considerations beyond simply whether an expenditure is reasonable and

prudent. Id. at 516 (citing 220 ILCS 5/16-108(c) (West 2004) (“Charges for delivery services

shall be cost based, and shall allow the electric utility to recover the costs of providing

delivery services through its charges to its delivery service customers that use the facilities

and services associated with such costs.”)). The court also noted the utility bears the burden

of proof on this issue when it is litigated before the Commission. Id. at 515 (citing Citizens

Utility Board v. Illinois Commerce Comm’n, 276 Ill. App. 3d 730, 746 (1995)).

¶ 53 In support of its contention that the incentive plan benefitted ratepayers, ComEd cited

testimony from its expert witness that incentive plans benefit everyone, including customers,

because as “productivity rises, more attention is paid to cost control and more focus is given

to customer service.” (Internal quotation marks omitted.) Id. The court noted that while the

evidence certainly provided support for the utility’s position, it did not compel the conclusion

the utility sought. Id. The court rejected the utility’s argument that the incentive plan

benefitted ratepayers in the sense that attracting good employees raises the level of service

customers will receive, finding such a benefit is “too remote.” Id. Since the record did not

-13-

establish the cost-cutting measures included in the incentive plan necessarily benefitted

ratepayers, the court held the utility had not demonstrated the Commission erred in

disallowing the costs. Id. at 519. The court noted that because other performance-based

components of the incentive plan existed, the Commission could have reasonably concluded

that the earnings-per-share portion of the plan provided only a tangential benefit to

ratepayers. Id. The court recognized the notion that an earnings-per-share-based employee

incentive plan provides benefits to shareholders was hardly a controversial position. Id.

¶ 54 In this case, similar to Commonwealth Edison Co., the Commission determined incentive

compensation related to financial goals, affiliate goals or shareholder goals should not be

recoverable. Although the Commission accepted Hoover’s testimony that the plans were

designed to attract and retain highly qualified and motivated employees, the Commission

determined such reasoning did not demonstrate a sufficient nexus between the expense and

the customer benefit. The Commission agreed with the People’s witness that when incentive

compensation seeks to achieve goals that primarily benefit shareholders, then it is reasonable

to require that shareholders bear the cost of that incentive compensation.

¶ 55 Contrary to Peoples Gas’ contentions on appeal, both the Act and Illinois case law clearly

reflect the direct customer benefit standard was an appropriate standard for the Commission

to apply in this case. See Commonwealth Edison Co., 398 Ill. App. 3d at 519. Because the

Commission’s expertise in these matters entitles its decisions to great deference on review,

we will not reevaluate the credibility or weight of the evidence, nor substitute our judgment

for that of the Commission. See Commonwealth Edison Co., 398 Ill. App. 3d at 514.

Accordingly, we see no reason to disturb the Commission’s findings based on the record

before us. Id.

¶ 56 B. Pension Plan Costs

¶ 57 Peoples Gas also contends the Commission erred by excluding its prudent and reasonable

pension costs from the rate base. Specifically, Peoples Gas contends the Commission erred

in agreeing with the Staff’s and the People’s proposal that Peoples Gas’ pension asset be

excluded from the rate base on the theory that the asset was established by ratepayer-supplied

funds.

¶ 58 Initially, we note Peoples Gas’ attempt to obtain recovery of the pension asset in its

previous rate case filed in 2007 was also denied by the Commission. Peoples Gas’ appeal

from that denial is still pending before the Second District.

¶ 59 For ratemaking purposes, the Commission notes a utility generally may not receive a

return on investment from ratepayers for ratepayer-supplied funds. See Business &

Professional People for the Public Interest v. Commerce Comm’n, 146 Ill. 2d 175, 258

(1991); Du Page Utility Co. v. Illinois Commerce Comm’n, 47 Ill. 2d 550, 554-58 (1971);

City of Alton v. Illinois Commerce Comm’n, 19 Ill. 2d 76, 85-91 (1960); Central Illinois

Light Co. v. Commerce Comm’n, 252 Ill. App. 3d 577, 583 (1993).

¶ 60 During the hearing before the Commission in this case, Peoples Gas argued there was no

evidence indicating customers funded the pension asset.

¶ 61 Alan Felsenthal, the Utilities’ primary witness on this issue, explained the pension asset

-14-

consisted of direct contributions by Peoples Gas shareholders and/or negative pension

expenses–in both cases, investor-supplied funding. Felsenthal explained a negative pension

expense results either from the expected return on prepaid plan assets exceeding other

components of pension cost, or from some of the pension plan participants accepting lump-

sum distributions in lieu of pension plan benefits. Felsenthal testified that for the eight-year

period between 1998 and 2003, Peoples Gas had a negative pension expense totaling $174.3

million. Felsenthal testified Peoples Gas’ pension asset is the cumulative difference between

what has been contributed to the pension plan by Peoples Gas using investor-supplied funds

and what has been expensed under the applicable accounting standards.

¶ 62 Felsenthal further explained that because the ratemaking process is based on the utility’s

expenses, the prepaid pension asset represents amounts that have been contributed by

Peoples Gas to the pension fund that have not been recovered from ratepayers or that have

been treated as a negative pension expense. Felsenthal testified customers benefit from

negative pension expenses because they reduce operating expenses and reduce the need for

additional rate cases. Felsenthal explained negative pension expenses benefit investors only

to the extent the expenses reduce cash funding requirements since gains or returns realized

on pension fund investments must stay in the pension fund. Because the Commission has not

allowed Peoples Gas to include its pension asset in the rate base, investors have not been

allowed to earn a return on their investment. Felsenthal stressed there was no evidence

indicating customers funded the pension asset.

¶ 63 Both the People and the Commission’s Staff disagreed with Peoples Gas’ argument that

the pension asset was created with funds supplied by shareholders, not ratepayers. The Staff

argued the pension asset was created with contributions using monies supplied by ratepayers

through the collection of utility rates. Since the pension asset was funded by normal

operations, rather than provided by shareholders, the Staff argued shareholders should not

be allowed to earn a return on it.

¶ 64 The Commission determined that although Peoples Gas argued the pension asset was

created with shareholder funds, no evidentiary support was provided. Accordingly, the

Commission found no support in the record to allow for the inclusion of Peoples Gas’

pension asset in the rate base, which would have the effect of allowing shareholders to earn

a return on ratepayer supplied funds.

¶ 65 Peoples Gas contends on appeal that our supreme court has previously rejected a claim

that a utility’s rate base should be reduced on the theory that part of it was the product of

consumer-supplied funds, citing Citizens Utilities Co. of Illinois v. Illinois Commerce

Comm’n, 124 Ill. 2d 195 (1998).

¶ 66 In Citizens Utility Co., the utility operated what is known as a “contract plant.” The

question presented in the case arose from the different treatment accorded a contract plant

for tax purposes and for ratemaking purposes. When computing its federal income taxes, the

utility was allowed to deduct the depreciation in value of the contract plant, reducing the

amount of income taxes it was required to pay. When computing its income tax expense for

rate making purposes, however, the utility did not factor in the depreciation deduction, and

therefore its income tax expense for ratemaking purposes was higher than what the utility

-15-

actually paid the federal government. The higher tax expense figure was used in ratemaking

cases for the years 1958 through 1982, netting a total of $4,657,385 in tax benefits. When

the error was discovered by the Commission in the utility’s 1983 rate case, the Commission

ordered that $403,432 in tax depreciation expense for the 1983 test year be deducted from

the utility’s taxable income. The Commission also ordered the balance of the past benefits,

$4,253,953, be deducted from the utility’s rate base. The utility appealed, contending the

$4.2 million rate base reduction was invalid as retroactive ratemaking.

¶ 67 The supreme court held the real effect, whether intended or not, of the $4.2 million

reduction in the utility’s rate base was to deny retroactively the tax benefits the Commission

permitted the utility to enjoy during the period from 1958 to 1982. Citizens Utilities Co. of

Illinois, 124 Ill. 2d at 206-07. The court held such action clearly conflicted with fundamental

principals of ratemaking in Illinois. Id. at 207. In reaching its conclusion, the supreme court

rejected the Commission’s contention that the $4.2 million reduction could be justified on

the ground that the reduction was necessary to prevent the company from earning a return

on non-investor-supplied capital. Id. at 211. The Commission believed that even though the

tax benefits did not become a discrete component of the utility’s rate base, they represented

customer-supplied funds, and, therefore, the utility’s receipt of them necessitated an

offsetting reduction in rate base. See Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151

(1934); City of Alton, 19 Ill. 2d 76. The supreme court noted, however, that the amounts at

issue before it were already recovered by the utility in past ratemaking orders as part of its

income tax expense, and the validity of those orders cannot now be questioned. Citizens

Utilities Co. of Illinois, 124 Ill. 2d at 212. The court also noted that although the Commission

order contained language suggesting that the tax benefits were non-investor-supplied capital,

the order did not state that a reduction would be necessary to prevent the company from

earning a return on those sums in the future. Id. at 205.

¶ 68 In this case, unlike Citizens Utilities Co., the Commission’s actions in determining

Peoples Gas’ pension asset should not be included in the rate did not constitute retroactive

ratemaking. The Commission is not attempting to correct for a past error of omission by

deducting the pension asset from the rate base. Instead, the Commission’s decision is based

solely on what impact the pension asset should have on Peoples Gas’ current rate base,

assuming the asset consists of customer-supplied funds. Because we are not faced with a

retroactive ratemaking situation in this case, we find Citizens Utilities Co. provides little

guidance as to how to resolve the actual issue pending before us.

¶ 69 The central issue before us remains whether the Commission’s decision to exclude the

pension asset, which it found consisted of consumer-supplied funds, from Peoples Gas’ rate

base was against the manifest weight of the evidence. Both the Staff’s and the People’s

expert witness testified the pension asset constituted customer-supplied revenues and,

therefore, should be deducted from the rate base calculation.

¶ 70 Although Peoples Gas’ expert witness obviously disagreed with that assessment and

testified the pension asset was generated solely form shareholder revenue, we note the

credibility of expert witnesses and the weight to be given their testimony are generally

matters for the Commission to determine as the finder of fact. See Lefton Iron & Metal Co.

v. Illinois Commerce Comm’n, 174 Ill. App. 3d 1049, 1060 (1988). “Decisions of the

-16-

Commission are entitled to great deference because they arise out of the deliberations of

members who are much better qualified to interpret evidence supplied by specialists and

technicians.” Id. Accordingly, we must refrain from reevaluating the credibility or weight of

the evidence, or from substituting our judgment for that of the Commission unless the

Commission’s judgment was clearly against the manifest weight of the evidence. See

Commonwealth Edison Co., 398 Ill. App. 3d at 514.

¶ 71 Based on the record before us, we find the Commission’s decision with regard to the

pension asset deduction is not clearly against the manifest weight of the evidence.

Accordingly, we see no reason to disturb the Commission’s findings.

¶ 72 C. Market-Based Rate of Return

¶ 73 The Utilities contend the Commission erred in adjusting the Utilities’ market-based rate

of return on equity (ROE). Specifically, the Utilities contend the Commission’s adjustments

to the Utilities’ market-based ROE not supported by substantial evidence, and was arbitrary,

capricious and punitive.

¶ 74 In setting a utility’s ROE, the Commission is tasked with evaluating the employment of

financial models that quantify the likely cost of attracting capital investment during the times

that the rates will be in effect. Because the Utilities’ stock is not publicly traded, the financial

models were applied to a proxy group of publicly traded natural gas utilities with risk profiles

identified to be similar to those of Peoples Gas and North Shore Gas. The Commission noted

the Utilities’ expert witness used a constant growth discount cash flow (DCF) model to

determine a ROE estimate of 10.67%. The Staff’s expert used a non-constant DCF model to

determine a ROE estimate; however, the Commission disregarded the Staff’s non-constant

DCF model because its use was unsupported by the evidentiary record. The Commission

determined it was clear in the evidentiary record that if the Staff had used a constant DCF

model, the unadjusted ROE estimate would have been 11.76%. The Commission determined

the most reasonable approach was to average the Staff’s unadjusted estimate of 11.76% and

the Utilities’ unadjusted estimate of 10.67%, which averaged to a 10.73% estimated ROE.

The Commission then made two types of downward adjustments to the ROE estimates,

which equaled an authorized ROE of 10.33% for North Shore and 10.23% for Peoples Gas.

¶ 75 The first adjustment was based on a “financial risk adjustment” of 30 basis points for

Peoples Gas and 20 basis points for North Shore. The Staff’s expert witness, Michael

McNally, explained the Utilities had less financial risk than the publicly traded utilities in

the proxy group. In order to determine the risk differential, McNally explained he compared

the proxy group’s average actual credit rating to hypothetical credit ratings he estimated the

Utilities would have if they recovered their revenue requirements in full. Finding the

Utilities’ hypothetical credit ratings based on full revenue recovery were higher than the

proxy group’s average actual credit rating, McNally and the Staff recommended the

deductions adopted by the Commission above. The second adjustment was based on 10-point

downward adjustments for each of two tariff riders approved by the Commission, Rider UEA

and Rider VBA.

¶ 76 Our supreme court has noted a utility’s revenue requirement is based on a calculation of

-17-

the utility’s:

“operating costs, rate base, and allowed rate of return. A public utility is entitled to

recover in its rates certain operating costs. A public utility is also entitled to earn a

return on its rate base, or the amount of its invested capital; the return is the product

of the allowed rate of return and rate base. The sum of those amounts–operating costs

and return on rate base–is known as the company’s revenue requirement. The

components of ratemaking determination may be expressed in the classic ratemaking

formula R (revenue requirement) = C (operating costs) + Ir (invested capital or rate

base times rate of return on capital). *** The revenue requirement represents the

amount the company is permitted to recover from its customers in the rates it

charges.” (Internal quotation marks omitted.) Citizens Utilities Co. of Illinois v.

Illinois Commerce Comm’n, 124 Ill. 2d 195, 200-01 (1988).

¶ 77 1. Financial Risk Adjustment

¶ 78 The Utilities contend the financial risk adjustment to the Utilities’ ROE should be

reversed. Specifically, the Utilities contend the adjustments were based on improper

assumptions and an improper comparison between the Utilities’ ideal financial performance

and the proxy group’s actual financial performance. The Utilities contend there was no basis

for the Commission to consider comparisons between the Utilities and the proxy group for

specific risk differentials. The Utilities note that for purposes of calculating the Utilities’

ROE through financial models, the Commission accepted the gas group proxy as a

reasonable proxy for the overall investment risk associated with the Utilities. Accordingly,

the Utilities contend the Commission’s consideration of a comparison specific to financial

risk was improper because the Commission did not also take into account other risk

variations that may have offset any differences in financial risk.

¶ 79 The Utilities also contend it was patently unfair and an abuse of discretion for the

Commission to assume full recovery of the revenue requirements when comparing the

Utilities’ future financial performance with the actual average credit rating of the proxy

group utilities. The Utilities contend their actual earnings are inherently uncertain because

their rates are based on estimated revenue requirements. In support, the Utilities note they

have significantly under recovered their revenue requirements in the past. In 2008, for

example, Peoples Gas earned a return of 5.65% compared to its 10.19% authorized return,

while North Shore earned 6.66% compared to its authorized return of 9.99%. Accordingly,

the Utilities contend the Commission grossly overstated their projected financial

performance and understated their financial risk when making the adjustments.

¶ 80 The Commission counters that it accepted the Staff’s testimony that the financial risk of

the Utilities is lower than that of the proxy group. The Commission contends the purpose of

the adjustment was to reflect the fact that the Utilities have, and will continue to have, in

place several risk reducing factors that not all companies in the proxy group have. The

Commission notes the Utilities’ own expert witness acknowledged that fact during the

hearing. Noting the proxy continues to be both theoretical and a matter of opinion, the

Commission contends the Utilities have not shown an opposite conclusion to the

-18-

Commission’s decision to adjust the ROE was “clearly evident.” See Continental Mobile

Telephone Co. v. Illinois Commerce Comm’n, 269 Ill. App. 3d 161, 171 (1994) (“On appeal

from an order of the Commission, the appellant bears the burden of proving that it was not

supported by substantial evidence. (220 ILCS 5/10-201(d), (e)(iv) (West 1992)). This

standard is not met by merely showing that the evidence may support a different conclusion;

it must be shown that the opposite conclusion is clearly evident.”).

¶ 81 The Commission’s findings of fact are to be considered prima facie true; its orders are

considered prima facie reasonable; and the burden of proof on all issues raised in an appeal

is on the appellant. See United Cities Gas Co., 163 Ill. 2d at 11. After reviewing the record

below, we agree it was proper for the Commission to accept the Staff’s expert testimony that

the financial risk of the Utilities at issue here is lower than that of the proxy group. Because

we conclude the Utilities have failed to demonstrate an opposite conclusion regarding the

Commission’s financial risk adjustment is clearly evident, we find the Commission did not

err in making the adjustment to the Utilities’ estimated ROE. See Continental Mobile

Telephone Co., 269 Ill. App. 3d at 171.

¶ 82 2. Rider Adjustment

¶ 83 Initially, we note a similar issue regarding an adjustment to the Utilities estimated ROE

based on Rider VBA in its 2007 rate case is currently pending on appeal before the Second

District.

¶ 84 The Utilities contend the additional 10-point adjustment to the ROE for Rider VBA,

which was designed to ensure accurate recovery of the Utilities “margin” revenues regardless

of how weather affected the Utilities’ sales of natural gas, and the 10-point adjustment to the

ROE for Rider UEA, which was designed to ensure recovery of the Utilities’ uncollectible

expenses, were duplicative and unnecessary. The Utilities note that to the extent the riders

increase the likelihood that the Utilities would recover a greater portion of their future

revenue requirements as compared to the proxy group, the Commission already assumed the

Utilities would recover their future revenue requirements in full when it made the financial

risk adjustment discussed above. Simply put, the Utilities suggest the adjustments for the

riders double counted the alleged risk differential between the Utilities and the proxy group

that the adjustments were designed to offset. The Utilities contend that the financial risk

adjustments, in effect, assumed the existence of a “super rider” that would ensure the

Utilities would earn their full revenue requirement regardless of any contingencies.

¶ 85 The Commission counters its decision to lower the ROE based on the rider was properly

based on the evidence presented by McNally, the Staff’s expert witness on the issue. The

Commission also disagrees with the Utilities’ contention that the risk adjustment was

designed to remove all risk that a utility will be unable to recover its revenue requirement in

full. In support, the Commission notes that under cost-based ratemaking, the authorized

return on common equity is set equal to the investor required return, which is revealed

through the price investors are willing to pay for that common stock. The Commission

contends a ROE cannot be determined by past achieved returns alone.

¶ 86 The Commission also notes determining an appropriate cost of common equity is not a

-19-

matter of formula, but, instead, is a question of pragmatic business judgment to which the

Commission’s decision is entitled to great weight. See Village of Apple River v. Illinois

Commerce Comm’n, 18 Ill. 2d 518, 523 (1960).

¶ 87 We must agree with the Commission in this instance. As previously noted, we will not

reevaluate the credibility or weight of the evidence on review; nor will we substitute our

judgment for that of the Commission. Commonwealth Edison Co., 398 Ill. App. 3d at 514.

Such deference is “especially appropriate in the area of fixing rates.” Iowa-Illinois Gas &

Electric Co., 19 Ill. 2d at 442. Because we determine the Utilities have failed to demonstrate

an opposite conclusion regarding the Commission’s rider adjustment is clearly evident, we

find the Commission did not err in making the adjustment to the Utilities’ estimated ROE.

¶ 88 CONCLUSION

¶ 89 We affirm the Commission’s order in part, reverse the order in part, and remand for

further proceedings consistent with this opinion.

¶ 90 Affirmed in part and reversed in part; cause remanded.

-20-