Amicus Curiae Brief — Duquesne Light Co. v. Barasch

we <> Supreme Court, U.S.

‘' HILED

No. 87-1160 ; JUN 30 1588

SEGSECH E. SPANMOL, JR,

ee

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1987

DUQUESNE LIGHT COMPANY,

—— POWER COMPANY Appellants,

Vv.

DAVID M. BARASCH, CONSUMER ADVOCATE, et al.

Appellees.

On Appeal from the

Supreme Court of Pennsylvania

BRIEF FOR THE NATIONAL ASSOCIATION

OF STATE UTILITY CONSUMER

ADVOCATES AS AMICUS CURIAE

STEVEN W. HAMM

Consumer Advocate

South Carolina

Co-Chairman

NASUCA's Electric

Committee

National Association

Of State Utility

Consumer Advocates

So. Carolina Depart.

of Consumer Affairs

2801 Devine Street

Post Office Box 5757

Columbia, SC 29250

(803) 734-9464

*Counsel of Record

RAYMON E. LARK,

Ass‘t Consumer

Advocate

Co-Chairman

NASUCA’S Electric

Committee

JR.*®

WILLIAM J. HERRMANN

Chief Counsel for

Illinois Governor's

Office of Consumer

Services

NASUCA Members

SUE A. HERRMANN

NANCY GAITSKILL

of Counsel

TABLE OF CONTENTS

PAGES

Guestiem PESOGMCSR. ccccccecacessesececeess i

TEDLS GE BUEROCECAGS cc ccccccecsececesscoesse ii

Interest of Amicus Curiae........ ese eeeeees 1

Summary Of Argument... ... cece ewes eevee svves 2

I. THE REGULATORY PRINCIPLE OF USED

AND USEFUL Is A CONSTITUTIONALLY

VALID REGULATORY TOOL.........2eeeees 5

A. Utilities Enjoy a Privileged

BEOMOROLY BESTE. ccccccccccccececesece 5

B. This Court, State Supreme Courts,

and Regulatory Bodies Utilize

“USGS GRE VWROEEE .cccccccccccccececs 12

C. Hope: Its Predecessors And Progeny Do

Not Establish A Constitutional Right

To Return Of Or On Property That Is

Not Used And. Useful........c ee eeeees 27

CI, 6. 0 606666606 668 HE 64S 644460 SEER 47

QUESTION PRESENTED

Whether a state may constitutionally

require utility property to be used and

useful in providing service to ratepayers

before the property is included in the

utility's rates?

“er. ee

TABLE OF AUTHORITIES

CASES: PAGES

Block v. Hirsh, 256 U.S. 135

ee nos se tec esecveceveces 38

es , rm /

Public, 485 N.E.2d 610(Ind. 1985)

Teen eT cee eseccecece 20

: icati Satellite Cor

Vv. FCC,

611 F2d 883 (D.C. Cir. 1977)

Ne cee eeceseoccece 14

aid

v. Sandford, 164 U.S. 578 (1896)

ee oc ceeersccccorce 30, 39

Denver Union Stock Yard Co. v. United

States, 304 U.S. 470 (1938)

° oeeeeveeeeeeeeeeeeeeeeeeeeeeeeeeee > 18

Federal Power Commission v. Natural Gas

Pipeline Co. of America, 315 U.S. 575

Ee ee ed eet sees cesses 16, 37,

Te ccc ceesecte 38, 39,

- iii -

Federal Pow mmi v. H N ral

Gas Co., 320 U.S. 591 (1944)

eéue bess 684066% 6 we eee eens 24, 37,

PP Pa ON ey te Fr ee 38, 42

wa- n l ric y,

Iowa S. Comm. Comm'n, 347 N.W.2d 423

COR BE 64.65 0006 0 i66580b 0b KEENE 9, 19

w r n

Regulatory Comm'n, 810 F.2d 1168 (D.C. Cir.

» RAPrprereser reo tre rere ete 45

Los Angeles Gas and Electric Corp. v.

j mmi j f ifornia,

ek ee of) RP reer 15

Madison Gas and Electric Co. v. Public

Service Commission of Wisconsin,

109 Wis. 2d 127, 325 N.W.2d 339 (1982)

TPP T Te TTT eT eT Tee eC TE Ee TLE 19

Market Street Railw v

Commission, 324 U.S. 548 (1945)

066455 06 5606000666066 50000 068606 17, 40,

TUTTE TTTE TCT T TCC CCT UTE ee 41, 42

Missi iE i Light ¢c

<. Shake of Mieelenent . No. 86-1970

(June 24, 1988)

COOSSOHSNESOEOESEESEEESSCESOEHSEHEC CHEESE OOSS 22

Missouri ex. rel. S.W. Bell Tel. Co,

v. Public Service Commission, 262 U.S.

276 (1923) (Brandeis, J., concurring)

WYETTTITCTITL TT CCS TTT Te eT 14, 31,

PTTTTITCTTEC TT Te TT eet te ee (>) ae: -

PUTT TTT TT eT eT 34, 35,

- iv «

Munn v. Illinois, 94 U.S. 113

DU ha a ee eg Ce

Nebbia v. New York, 291 U.S. 502

tae a a ne i ak a 38,

NEPCO Municipal Rate C itt .

668 F.2d 1327 (D.C. Cir. 1981)...... age

, 390 U.S

ee ee 17,

a 43,

Philadelphia Electric Co. v

61 Pa. Commw. 325, 433 A.2d 620 (1981)

Public Serv; ; Bae le "

Montana-Dakota Utilities Co., 100 N.wW.

ss ££ 5 0 |= eee 19,

Vv : ’

BOO Delle SE BBs cccvchececceces 14,

oeeeeeeeeeeeeeeeeeeee Coeeeeveenegeeeneeeeeee

Smyth v. Ames, 169 U.S. 466 (1898)

Cee 4b Skok RO ood heeded Okan 13,

ih shina Cad eeedan koe deha~wsauwaae 31,

9b Woke eee a es na ee ab oad ole os 35,

r : Pipeli - =

Energy Regulatory Commission, 606

F.2d 1094 (D.C. Cir. 1979)

45

18

19,

44

19

j Fuel v. Rail

Commission of Kentucky, 278 U.S. 300

ccc c Ll cee e ete Cbhebebbe bob 4s 6 e808 5

Washington Gas Light Comm'n v. Baker,

188 F.2d 11 (D.C. Cir. 1950)

deta ait ea anaes eas IO a ike te wae 45

ADMINISTRATIVE DECISIONS:

City of Bend v. Bend Water, Light,

and Power Co., Pub. Util. Rep. (PUR)

SOnee GES CUOO. BuBcSc - BORB) 2c cicccsccce 19

Mayor of City of Everett v. Malden

and Melrose Gas Light Co., 78

Pub. Util. Rep. (PUR) (NS) 129,

Cs Delete BPC Ghee ves ee eeeseeeseses 19

Vv vani w n ight,

67 Pub. Util. Rep. (PUR) 4th 30

Tre. Be. GOR Beet esctecsccetnceces 19

Re Arkansas Power and Light Co.,

66 Pub. Util. Rep. (PUR) 4th 167 (Ark.

Publ. Serv. Comm'n 19865)... cccccccccecs 19

Re Consumers Power Co., 14 Pub. Util.

Rep. (PUR) 4th 1 (Mich. P.S.C. 1976)

aaa A a i eebne be 19

- Wi -

Re Iowa-Illinois G s Blectric Co.,

46 Pub. Util. Rep. (PUR) 4th 616

(Towa &.C.C. 1982)... .cccccccccccccvcces 20

Re Kansas City Power and Light Co.,

75 Pub. Util. Rep. (PUR) 4th 1 (Mo.

Publ. Serv. Comm'n 1986)..........00e08- 19

Re Tampa Electric Co., 92 Pub. Util.

Rep. (PUR) 3d 398 (Fla. P.S.C.

oy. eee ee re, eg 19

Re The Chesapeake and Potomac Telephone

Co., 57 Pub. Util. Rep. (PUR) 3d 1

ee ee rere 19

P ae ;

pe Eg gy Bey

Co., 51 Pub. Util. Rep. (PUR) 4th 158

(Wash. Ut. & Tr. Comm. 1983)

Drobak, From Turnpike to Nuclear Power:

The ¢ tituti 1 Limit Utilit

Phillips, The Regulation of Public

tilities: 7

_and Practice,

- vii -

Pierce, The R l ry Tr men 4

n o-,. igs @.

of Penn L.R. 496 (1984)............. 22, 26

McKeage, j ili R rc Ww,

ER 66 4604600 666K400-090060606000064056%0% 25

Schwartz,

Regulation, 4 Utah L. Rev. 89

2 EE ee re ee ee ee ee een 26

Wilcox, i ici Tow in

+ & 8B. yee e prey errr ll

No. 87-1160

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1987

DUQUESNE LIGHT COMPANY,

AND

PENNSYLVANIA POWER COMPANY Appellants,

Vv.

DAVID M. BARASCH, CONSUMER ADVOCATE, et al.

Appeliees.

On Appeal from the

Supreme Court of Pennsylvania

BRIEF FOR THE NATIONAL ASSOCIATION

OF STATE UTILITY CONSUMER

ADVOCATES AS AMICUS CURIAE

INTEREST OF AMICUS CURIAE

The National Association of State

Utility Consumer Advocates (NASUCA) files

this brief as amicus curiae in support of

appellees. NASUCA members represent

electric consumers in thirty-seven states

and the District of Columbia. NASUCA urges

this Court to affirm the decision of the

Supreme Court of Pennsylvania. A reversal

will have a dramatic, immediate, and

negative impact on the traditional scope of

state regulation of investor-owned public

utilities. Those participating as

consumers and advocates for consumers in a

changed state regulatory process will be

detrimentally affected. NASUCA submits

this brief with the consent of the parties,

and files written verification of this with

the Clerk pursuant to Supreme Court Rule

36.2.

SUMMARY OF ARGUMENT

A monopoly status was granted to

electric utilities in the belief that these

utilities were natural monopolies. In

return for the privileged monopoly status,

electric utilities are subject to

government regulation. The purpose of

regulation ‘s to be a surrogate for

competition in determining just and

reasonable rates. In fulfilling its

function, regulation must balance the

conflicting interests of both the consumer

and the investor.

To accomplish this difficult task,

regulation has developed certain regulatory

principles. Perhaps the most important of

these principles is that rates must be

determined only on a utility's investment

actually providing a service to the

ratepayer. The exclusion of property not

used and useful from a utility's rates

results in an equitable allocation of

risks between consumers and investors, and

is necessary ia order to provide incentives

to a utility to operate efficiently.

This Court has never interpreted the

Constitution to establish an investor right

to receive a profit on property that has no

value in serving the public. The

Pennsylvania Supreme Court's decision in

upholding a Pennsylvania law prohibiting

the inclusion of cancelled plant in a

utility's rates was proper. Cancelled

plant has no value and the recognition of

this obvious fact is entirely appropriate.

This Court has ruled many times.that due

process only prevents destruction of value

by government action and cannot be applied

to restore values that have been lost by

the operation of economic forces.

ARGUMENT

THE REGULATORY PRINCIPLE OF USED

AND USEFUL IS A CONSTITUTIONALLY

VALID REGULATORY TOOL.

A. UTILITIES ENJOY A

PRIVILEGED MONOPOLY STATUS

Tnis Court in United Fuel Gas Co. v.

Railroad Commission of Kentucky, 278 U.S.

300, 209 (1929), observed that a regulated

public utility exercises an extraordinary

privilege and occupies a privileged

position as compared to other. profit

motivated private enterprises. Under

regulation a public utility is granted a

monopoly status and is sheltered against

many of the hazards to which the

unregulated business is ,subject.

ee

History shows that as the electric

industry developed in this country,

individual state legislatures gradually

determined that electric companies were

natural monopolies and that it was in

society's interest to grant them a monopoly

status. It was widely believed that

competition between electric companies

could interfere with efficient supply of

the service. At the same time, the

economics of producing electricity, at

least in the early days, indicated that the

industry was on a decreasing cost basis -

the more a company produced the less its

cost of production.

In this context legislators

disregarded one of the basic premises of a

free enterprise system: that free

competition resulted in the best allocation

of society's resources and resulted in a

fair price for an adequate output of

goods. They allowed electric companies to

become monopolies. In utility regulation

the privileged monopoly status is conveyed

to the private utility in return for the

utility's obligation to provide reliable

service to the public.

However, government regulation was

needed to offset the natural tendency of a

monopoly to be inefficient and exhibit

other behavior inimical to the public

interest, i.e., reducing output in order to

extract a higher price. Therefore electric

utilities, in return for their state

created monopoly status, are regulated by

the state.

The goal of utility regulation is to

determine rates that would result from free

competition if free competition were

possible. The regulator has the difficult

and complex role of determining rates that

are just and reasonable from both the

captive ratepayer and investor perspectives.

The interest of the consumers in

receiving the best service at the lowest

rates possible and the profit motive of the

investor are at odds in this case. The

public interest in not being required to

pay for something that will never have any

value to them nor ever be useful to any

segment of society, far outweighs’ the

investor interest in receiving a profit on

a failed investment. The Pennsylvania

legislature and the Pennsylvania Supreme

Court concluded similarly.

Regulators have to balance’ these

interests in a continually changing

economic atmosphere. Generally speaking,

though, a utility is entitled to rates

which provide an opportunity to yield

revenues sufficient to meet operating

expenses, taxes, and provide a fair return

on its rate base. Rate base is defined as

the dollar value of a company's plant and

equipment that is serving the public.

wa- j Vv w m

Comm'n, 347 N.W.2d 423 (Iowa 1984). A

utility is entitled to a reasonable profit

or rate of return on this used and useful

property, so long as it was procured under

conditions of prudent and efficient

management.

Rate of return is the cost to the

utility of its financing incurred to

produce its plant and equipment. Rate of

return has three components - cost of debt,

preferred stock, and equity or common

stock. In any determination of rate of

o MH <

return, the cost of debt and preferred

stock are fixed amounts and their values

can be determined by simple arithmetic.

The cost of equity basically determines the

profit the utility will be allowed to

earn. By its very nature this

determination is subjective and depends

upon what regulators perceive to be a fair

return or profit on investment. Implicit

in an allowed rate of return is a risk

premium. The risk premium compensates the

investor for the risk that his investment

may be unsuccessful.

Within the context of this ratemaking

formula, regulation has to fulfill its

function as a substitute for competition.

Regulation must not only prevent the

utility from charging excessive rates,

impairing the quality of its service and

e

» £2 ©

earning excessive profits; but it must also

provide incentives to improve quality and

to increase efficiency. Even though this

goal of regulation is clear and

indisputable, achieving it is extremely

difficult. Regulatory agencies can neither

acquire nor effectively utilize the range

of data which influence a competitive

market.1 The difficulties of regulation

are largely inherent in the nature of the

undertaking’ itself. "It cannot prescribe

quality, force efficiency, or require

innovation, because such action would

invade the sphere of management. But when

it leaves these matters to the discretion

of industry, it denies consumers the

protection that competition would afford."2

1 Phillips, The Regulation of Public

Utilities: Theory and Practice (1985) at

154, quoting from former FCC chairman, Lee

Loevinger, , n n n

Alternatives, ll The Antitrust Bulletin

101, 125 (1966).

2 Wilcox, Public Policies Toward Business

(3d ed.), at 476-77.

—:

B. THIS COURT, STATE SUPREME COURTS,

AND REGULATORY BODIES

CONSTITUTIONALLY UTILIZE THE USED

AND USEFUL PRINCIPLE.

Realizing that public utility

regulation is inherently incapable of

supplying the kind of continuous pressure

and incentives for the efficient operation

of a utility that competition ordinarily

supplies in non-regulated industries,

several states have developed regulatory

principles to compensate for the lack of

competition. One widely accepted principle

is that rates must be determined only on an

investment actually providing a service to

the ratepayer or on property that is used

and useful. The used and useful principle

balances the interests between the

ratepayer and investor by protecting the

consumer from unr cessary or excessive

investment while allowing investors a

o w=

return on the capital which they have

reasonably devoted to public use. The used

and useful test serves ,.to measure precisely

how much property is devoted to the public

for which a return can be- expected.

Beginning with Smyth v. Ames, 169 U.S. 466

(1898), this Court found that a utility is

entitled to a return upon that property

which is used and devoted by it to the

public convenience. On the other hand,

property which is not used and useful for

the public convenience is not to be

included as a basis for making rates.

ver r __v. United

States, 304 U.S. 470, 475 (1938). The used

and useful test has been accepted by the

vast majority of jurisdictions as a means

of distinguishing between property included

in rates and property appropriately

excluded.

Some jurisdictions apply the used and

useful test in conjunction with the

reguirement that the investment be

prudent. With respect to the prudence

requirement, it is clear that ratepayers

are not to be charged for negligent,

wasteful or improvident expenditures, or

for the cost of management decisions which

are not made in good faith. Reagan v.

Farmers' Loan & Trust Co., 154 U.S. 362,

412 (1894). Ratepayers are not expected to

pay for management's lack of honesty or

sound business judgment. Missouri ex rel,

WwW 1 Vv Vv , 262

U.S. 276, 290 n.1l (1923) (Brandeis, J.

concurring). This Court has never held,

however, that a utility reglatory-agency is

limited solely to a prudence analysis.

Communications Satellite Corp. v. FCC, 611

F2d 883, 890 (D.C. Cir. 1977).On the

3. The prudent investment test is widely

credited to Mr. Justice Brandeis. Whether

he intended to limit a regulatory body to

this test is questionable. He developed

this test with the history of the railroads

in mind. As he explained, this history was

replete with examples of fraud on

ratepayers. See infra note 8.

—

contrary, it is simply one of several tools

available to the regulator.

Even if the prudence test is used,

the investigation into what property should

be included in rates cannot realistically

end with that analysis as appellants

argue. A competitive market does not

differentiate between prudent and imprudent

investments. The market provides rewards

and penalties based on the result of the

investment decision. In a competitive

market, firms that cancel partially

completed plants for lack of demand do not

recover their investments. The harsh

consequences of misjudgments in the

competitive market provide powerful

incentives for prudent decisionmaking.

Moreover, this Court has long held

that prudently incurred property could be

excluded from rates. In Los Angeles Gas

and Electric Corp. v. Railroad Commission

of California, 289 U.S. 287 (1933), the

Court considered whether a plant designed

to manufacture natural gas which was no

longer in use should be included in rate

base. The Court noted:

The time and circumstances of the

outlay, and the effect of altered

conditions, demand consideration.

Even when cost is revised so as to

reflect what may be deemed to have

been invested prudently and in good

faith, the investment may embrace

property no longer used and useful for

the public.

Id. at 306.

Similarly, in Federal Power

Commission v. Natural Gas Pipeline Co., 315

U.S. 575 (1942), where natural gas

producers alleged that the exclusion of

excess plant capacity from rate base was

confiscatory, the Court stated that there

was no constitutional right to the

inclusion of this value as a_ separate

item. Rather, it is “only on the

assumption that excess snpenten is a part

of the utility's equipment used and useful

in the regulated business, that it can be

included as a part of the rate base on

which a return may be earned.” 315 U.S. at

590. Also, in Permian Basin Area _ Rate

Cases, 390 U.S. 747 (1968), producers of

natural gas attacked the Federal Power

Commission's failure to include an adequate

allowance for exploration costs. Rejecting

the claim outright, the Court stated: “We

must emphasize that we perceive no

obligation upon the Commission, under the

Constitution or the Natural Gas Act, to

permit recovery of all exploration costs,

regardless of their amount and prudence.”

390 U.S. at 825 n.115. Indeed, in Market

Street Railway Co. v. Railroad Commission,

324 U.S. 548 (1945), this Court rejected

the proposition that every prudent

— oe

investment must be included in rates. 324

U.S. at 567. See also infra at 40-42;

Denver Union Stock Yard Co, v. United

States, 304 U.S. 470, 476 (1938).

In Tennessee Gas Pipeline Co. v.

Federal Energy Regulatory Commission, 606

F.2d 1094 (D.C. Cir. 1979), the issue was

whether FERC had properly excluded certain

investments from rate base. The Court

asserted that the investment must be used

and useful. "These investments were

prudent investments, argues Transco;

however, for rate base inclusion

expenditures must satisfy not -only the

necessary condition of prudent investment

but also must be ‘used and useful’ in

providing service." Id. at 1123. Accord,

Energy Regulatory Commission, 668 F.2d

1327, 1333 (D.C. Cir. 1981).

—

Many state courts’) and commissions

have recognized the validity of the used

and useful test in addition to an analysis

of prudency.4 Typical of the analysis is

4 wa- j Vv Ww

Com Comm'n, 347 N.W.2d 423, 429 (Iowa

1984); Madison Gas and Electric Co. v.

J vi * .* Wi J ‘ 325

Public Service Commission of Wisconsin

N.W.2d 339 (Wis. 1982); Philadelphia

Elect ri 5 8 lvania Public Utili'

Commission, 61 Pa. Commw. 320, 433 A.2d 620

(1981); Public Service Commission Vv.

Montana-Dakota Utilities Co., 100 N.W.2d

140, 150 (N.D. Sup. Ct. 1959); Re Kansas

j w j , 75 PUR 4th 1, 125

(Mo. Pub. Serv. Comm'n. 1986); Pa. PUC v.

Pennsylvania Power and Light, 67 PUR 4th 30

(Pa. Pub. Util. Comm'n. 1985); Arkansas

Power and Light Co., 66 PUR 4th 167, 183

(Ark. Publ. Serv. Comm'n. 1985);

51 PUR 4th 158, 167 (Wash. Ut. & Tr. Comm.

1983); Re Consumers Power Co., 14 PUR 4th

he 15 (Mich. P.S.C. 1976); Re Tampa

Electric Co., 92 PUR 3d 398, (Fla. P.S.C.

1971); Re The Chesapeake and Potomac

Telephone Co., 57 PUR 3d l, 6 (D.C. P.§.C.

1964); Mayor of City of Everett v. Malden

and Melrose Gas Light Co., 78 PUR (NS) 129,

132-33 (Mass. D.P.U. 1949); City of Bend

v. Bend Water, Light, and Power Co., PUR

1915F 913, 917 (Ore. P.S.C. 1915).

—

Re Iowa-Illinoi 5; i Electri “es . 66

PUR 4th 616 (Iowa S.C.C. 1982). There the

Iowa Commission expressly rejected sole

reliance upon the prudence standard urged

by the utility.

The “prudency” test Iowa-Illinois

advocates would, taken to its logical

extreme, require us to allow

Iowa-Illinois a full return on any

amount of capacity, regardless of the

consequences to the consumer, so long

as the decision to invest in that

amount of capacity was justified at

the time it was made. We do not

believe the prudency test

Iowa-Illinois advocates is consistent

with sound regulatory principles.

Id. at 618.

In cases like the instant one

involving cancelled plants, the used and

useful principle is indispensable to

protect consumers. The Supreme Court of

Indiana, in Citizens Action v. Northern

Indiana Public, 485 N.E.2d 610 (Ind. 1985),

~ Se

noted the long-standing history of

evaluating property that is used and useful

in rate base. Id. at 614. Upholding the

disallowance of cancelled plant from rate

base, the court said:

[Wle have been unable to conceive of a

situation ... in which the consumers

could be required to replenish lost

capital which had never become “used

and useful" property or, in other

words, be required to act in aid and

support of the utility as an insurer

of the investor's risk, unless

consumers received an interest’ in

return which provided an opportunity

to earn a return on the capital

supplied.

Id. at 615.

The foregoing history establishes

that the used and useful standard is key to

determining rates that balance ratepayer

and investor interests. Appellants’

argument to the contrary is simply without

merit. Although the prudence standard may

be appealing in theory, it is extremely

unfair to limit a regulatory body solely to

» 2 =

that standard. There . are practical

problems with it, beyond proper regulatory

principles, that militate against the sole

application of the prudence standard.

Demonstrating the prudence and/or

imprudence of a utility's decision to

construct a new plant requires enormous

expenditures for expert witnesses.

Generally litigation costs of this

magnitude are beyond the reach of most

consumer groups and regulatory bodies.

Even the Federal Energy Regulatory

Commission (FERC) has noted that it does

not have sufficient resources to determine

whether a utility has acted prudently in

deciding to build a particular plant.®

5 Pierce, Th R 1 r men

Mistakes In Retrospect: Cancelled Plants

and Excess Capacity, 132 U. Pa. L. Rev.

496, 512 nn.80, 81 (1984). Even in light

of this Court's decision in Mississippi

~—e i Light ¢c v.. Stat 6 Mississippi

on June 24, 1988, FERC's responsibility to

conduct prudence reviews remains unclear

and may require Congressional action.

o

Additionally, in regard to a

utility's decisions in constructing a new

plant, regulatory review may not occur

until ten or fifteen years after’ the

decision. This length of time makes it

extremely difficult to gather the data and

evidence necessary to show imprudence as

well as prudence.

The other argument by the appellants

and amici for them that the used and useful

principle can only be applied in

conjunction with the fair value method of

determining rate base is spurious. They

cite no authority for this proposition

because this distinction has never been

made in any of the numerous cases which

applied the used and useful standard. The

basis of the argument seems to be that a

fair value rate base enables a utility the

opportunity to earn more dollars and

thereby be compensated for any potential

used and useful disallowance.

—

This perception is false. History

Shows that a fair value determination could

either increase or decrease the value of a

utility's rate base. The value will

constantly fluctuate in accordance with

economic cycles and trends. Given a

different economic climate, appellants

might have to change their position and

argue that the used and useful standard can

only be applied to original cost.

It was precisely because of the

difficulty in determining fair value that

this Court discarded this imprecise

valuation, and ruled that it. would no

longer be constitutionally mandated.

Federal Power Commission v. Hope Natural

Gas _Co., 320 U.S. 591 (1944). The Court

wisely removed itself from a debate that

one commentator at the time described as

follows:

- 25 -

The subject of valuation in the

regulatory field probably has

engendered more disagreement and

contrariety of opinion, and has

strained more friendships, than any

other subject with the possible

exceptions of religion, politics and

the keen dispute over the authorship

of the works attributed to William

Shakespeare. One might say, with the

full support of regulatory history,

that valuation comes close to what

might be truly characterized or

described as institucionalized

uncertainty.

The exclusion of property not used

and useful results in an equitable

allocation of risks between consumers and

investors, and provides adequate incentives

for efficient operation. The utility's

profit stems from receiving a_ rate of

6 McKeage, Public Utility Regulatory Law

63 (1956).

—

return on its rate base: the larger the

rate base, the higher the potential profits

for the utility. This results in a natural

incentive for utilities to build large,

capital intensive plants.? The most

Gangerous problem of including plant not

used and useful in rate base is that it

perpetuates this inappropriate incentive.

If a utility knows that its investments in

future plants will be included in rate base

even if cancelled prior to completion, it

is more likely that the utility will fail

to exercise sufficient caution in planning

its construction program. A -return on

cancelled plant removes a necessary

constraint on a utility to control the

costs and size of a construction program.

Regulatory Bodies that utilize a used and

7 Pierce, supra, at 506; Schwartz,

j n ili R ion, 4

Utah L. Rev. 89, 93 n.9 (1982)

—~

o SD. «

useful test are fulfilling their obligation

to determine fair and reasonable rates in

light of their role as _ surrogates for

competition.

Cc. HOPE: ITs PREDECESSORS AND

PROGENY DO NOT ESTABLISH A

CONSTITUTIONAL RIGHT TO RETURN OF

OR ON PROPERTY THAT iS NOT USED

AND USEFUL.

The statute at issue here, 66 Pa.

Cons. Stat. § 1315 (1982), like many state

statutes and regulatory practices,

disallows the cost of any plant not used

and useful. Appellants allege that the

statute and the Pennsylvania Supreme

Court's intrepretation of the statute

amounts to a taking of the utility's

property in violation of the 5th Amendment

of the United States Constitution. A

review of the cases before this Court

- 28 -

establishes that the denial of these costs

does not rise to the level of a “taking.”

In 1877, in Munn vy, Illinois, 94 U.S.

113 (1877), this Court upheld the right of

the State of Illinois to regulate the

Prices charged to farmers for the storage

of grain in grain elevators. The Court

there recognized that the public interest

may override the interests of private

enterprise. In Munn, a _ small number of

elevator operators had a "virtual monopoly”

and openly set uniform prices. 94 U.S. at

131. The Court held that businesses

“affected with a public interest" were

Subject to control, i.e., price regulation,

under the general police power in order to

Protect the public. 94 U.S. at 126.

Seventeen years later, in Reagan Vv.

Farmers' Loan & Trust Co., 154 U.S. 362

(1894), the Court hela that under the power

» 2 «

of eminent domain, if the state were to

take the appellant's (here a_ railroad's)

property, it would have to pay

compensation. Similarly, taking the use of

the property for public benefit at less

than its market value was equally a

taking. 154 U.S. at 410. The Court

emphasized, however, that:

It is unnecessary to decide, and we do

not wish to be understood as laying

down as an absolute rule, that in

every case a failure to produce some

profit to those who have invested

their money in the buiiding of a road

is conclusive that the tariff is

unjust and unreasonable. And yet

justice demands that everyone should

receive some compensation for use of

his money or property, if it be

possible without prejudice to the

rights of others.

154 U.S. at 412.

» 26 «

Shortly after Reagan, in Covington §&

Lexington Turnpike Co. v. Sandford, 164

U.S. 578 (1896), the Court required

turnpike rates high enough to pay

dividends, but only if there was no proof

that the public interest justified lower

rates. There was no unconstitutional

taking if the low rates reflected the value

to the public of the company's service, the

imprudence of investment, or losses caused

by competition. 164 U.S. at 596-97.

The principles of Reagan and Sandford

culminated in Smyth v. Ames, 169 U.S. 466

(1898). In Smyth, the Court reiterated the

Principle of Sandford that rates should

reflect the value of service to the

public. The Court rejected the plaintiff

railroads’ argument that would have

required the regulators in setting rates to

use the historical book value of the

» 22 «

railroad property, an amount far more than

the reproduction cost of the railroad

facilities because of the depressed economy

of the late 1800's and because of excessive

construction contracts, imprudent financing

and watered stock.8 Instead, the Court

adopted a rule that set rates at a level

that covered operating expenses and

provided a “fair return" on the “fair value

of property being used by it for the

convenience of the public." 169 U.S. at

546, 547.

8 Missouri _ex rel. S.W. Bell Tel. Co. _v.

i Vv

Public Service Commission, 262 U.S. 276,

298 (1922) (Brandeis, J., concurring);

Drobak, From Turnpike to Nuclear Power:

The Constitutional Limits on Utility Rate

, 65 Boston U.L.R. 65, 77-78 nn.

52, 53 (1985).

- 32 -

What the company is entitled to ask is

a fair return upon the value of that

which it employs for the public

convenience. On the other hand, what

the public is entitled to demand is

that no more be exacted from it for

the use of a public highway than the

services rendered by it are actually

worth.

Id. at 546-47. Although the Court listed

many factors to be considered in

determining fair value, Subsequent cases

reduced those factors to the reproduction

cost at the time of the rate hearing. See,

e.g., Missouri ex rel. S.W. Bell Tel. Co.

v. Public Service Commission, 262 U.S. 276,

290, 298 (1922).

While reproduction cost was favorable

to the public as applied to inflated

railroad construction costs during

depressed economic times, the situation

a 28 «

reversed during the inflationary period of

World War I.?9 In addition, replacement

cost failed to be the definite, calculable

number that regulating authorities’ had

desired. These woes were eloquently voiced

by Mr. Justice Brandeis in his concurring

opinion in Missouri, ex rel. S.W. Bell Tel.

Co. v. Public Service Commission, 262 U.S.

276 (1923) There he advocated laying to

rest the Smyth reproduction cost rule and

allowing the utility to earn “a fair return

on the amount prudently invested in it."

262 U.S. at 289. While attacking the Smyth

rule on the basis of its’ historical

foundations, which were no longer

applicable, and the fact that it

9 Missouri ex rel S.W. Bell Tel. Co. v.

Public Service Commission, supra note 8 at

299-301 (1923) (Brandeis, J., concurring);

Drobak, supra at 8l, n.8.

- 34 -

was unworkable in practice, Mr. Justice

Brandeis also changed the constitutional

inquiry from the prevailing eminent domain

philosophy of taking the utility's property

to that of taking the investors’ Capital.

262 U.S. at 290,10

The thing devoted by the investor to

the public use is not specific

property, tangible and intangible, but

Capital embarked in the enterprise.

Upon the capital so invested the

Federal Constitution guarantees to the

utility the opportunity to earn a fair

return.... The Constitution does not

guarantee to the utility the

Opportunity to earn a return on the

value of all items of property used by

the utility, or any of them.

10 Drobak, supra, at 82.

ne papal an

=» 26 «

262 U.S. at 290. He defined d

constitutionally adequate rate level as:

compensation which the

p14 guarantees an apg |

to earn is the reasonable cost an

conducting the business. Cos

includes not only operating aay woe ro

but also capital charges. Capi a

charges cover the allowance, by way ;

interest, for the use of po. maint Pe

whatever the nature of the — y

issued therefore; the allowance -o

risk incurred; and enough more fe)

attract capital.

262 U.S. at 291. While this measure was

intended to eliminate the vagaries inherent

in the Smyth test,/2 it made two

j ily varies

12 Reproduction cost necessarily

with the cost of labor, materials and

capital and other economic conditions.

o 5

assumptions. First, it assumed that any

investment, short of dishonesty or obvious

waste, was prudent. “Every investment may

be assumed to have been made in the

exercise of reasonable judgement, unless

the contrary is shown." 262 U.S. at 289

n.l. Second, it assumed that the property

in question was being used to. provide

service to ratepayers.

(T]he cost to the utility of the

Capital, required to construct, equip

and operate its plant, should measure

the rate of return which the

constitution guarantees opportunity to

earn [footnote omitted].... It would,

when once made in respect to any

utility, be fixed for all time,

subject only to increases to represent

additions to plant....

Id. at 306-07 (emphasis added).

The Smyth test, however, lingered

until the 1940's, when the Court released

Ska han ace AE OO fly nce Pele IS 2 tgs ee cole CaP er

BM ee 6 hrm at i 9

=.

regulators from their obligation to use any

one test in Federal Power Commission v.

Natural Gas Pipeline Co., 315 U.S. 575

(1942), and Federal Power Commission v.

Hope Natural Gas Co., 320 U.S. 591 (1944).

Both cases involved the constitutionality

of the Natural Gas Act of 1938, 15 U.S.C.

§§ 717, et seqg., which allowed the Federal

Power Commission to set rates to be charged

for the sale of natural gas. In Natural

Gas Pipeline, the Court held that “[t]he

Constitution does not bind rate-making

bodies to the service of any single formula

or combination of formulas." 315 U.S. at

586. Agencies could adjust to specific

circumstances as long as they acted within

their statutory authority, and as long as

the final order, “viewed in its entirety,"

did not produce an arbitrary result, the

Constitutional inquiry ended. Id.

—

Regulation “does not insure that’ the

business shall produce net revenues.” 315

U.S. at 590.

Shortly after, in Hope, where the

company challenged a commission order

reducing natural gas rates, the Court held

that if the statutory requirement of rates

that were “just and reasonable” under

section 5(a) of the Natural Gas Act is met,

judicial inquiry is at an end. 320 U.S. at

602. The end result, not the method used,

controls. Id. The Court re-emphasized

that price regulation may, indeed, reduce

the value of property regulated. Reduction

in value does not mean the repuleticn is

invalid. Id. at 601, citing Block v,

Hirsh, 256 U.S. 135, 155-57 (1921), and

Nebbia_ v. New York, 291 U.S. 502, 523-39

(1934). Moreover, setting "*just and

reasonable rates’ involves a balancing of

the investor and consumer interests." 320

U.S. at 603.

As the concurring opinion of

ec Als he

oe Me

Justices Black, Douglas and Murphy noted in

Natural Gas Pipeline, the correct principle

was that announced in Covington & Lexington

Turnpike Co. v. Sandford:

It cannot be said that a corporation

ie is entitled, as of right, and

without reference to the interests of

the public, to realize a given percent

upon its capital stock.... [Whether]

the rates prescribed are unreasonable

and unjust to the company and its

stockholders involves an inquiry

as to what is reasonable and just for

the public.

164 U.S. 579, 596 (1896) as quoted in

Natural Gas Pipeline, 315 U.S. at 607-08.

The Natural Gas Pipeline concurrence

emphasized that the investor interest is

not the only interest to be protected.

The investor and consumer interests

may so collide as to warrant the

rate-making body in concluding that a

~» 2 «

return on historical cost or prudent

investment though fair to investors

would be grossly unfair to the

consumers.

315 U.S. at 608.

The consumer interest was given

additional emphasis one year after Hope in

Market S1 ) Railw : - Rail ;

Commission, 324 U.S. 548 (1945). The

Market Street Railway Company operated

Street cars and buses in San Francisco.

Due to competition from expanding

municipally-owned lines, Market Street's

traffic and revenue began to decline. The

company asked for, and got, in 1939, a fare

increase from the area-wide 5 cent standard

to 7 cents. 324 U.S. at 555. Except for

an increase in traffic during war-time,

service continued to deteriorate even with

the increased fares. 324 U.S. at 556. The

California Supreme Court affirmed an order

oo ear

Satie

- 4] «=

of the Railroad Commission of California

reducing rates from 7 to 6 cents. 324 U.S.

at 552-53. Before this Court, the company

claimed the order was confiscatory under

Hope because the Commission used a rate

base of $7,950,006 (the price at which the

company offered to sell its properties to

the city). The company challenged the

Commission's failure to use reproduction

costs (approximately $29,000,000),

historical cost, prudent investment, or

capitalization bases, and the _ resultant

operating losses to the company. 324 U.S.

at 553-54. The return was not sufficient

to “'‘assure confidence in, the financial

integrity of the enterprise, so as_ to

maintain its credit and to attract

capital'” or to “‘enable the company to

operate successfully, to maintain its

financial integrity, to attract capital,

and to compensate its investors for the

- 42 «

risks assumed. '‘”" 324 U.S. at 566, citing

Hope, 320 U.S. at 603. Of Hope, the Court

Stated that “[a]1ll that was held was that a

company could not complain if the return

which was allowed made it possible for the

company to operate successfully." 324 U.S.

at 566. Moreover, due process only

prevents destruction of value by government

action.

[I]t may be safely generalized that

the due process clause has never been

held by this Court to require a

commission to fix rates on the present

reproduction value of something no one

would presently want to reproduce, or

on the historical valuation of a

Property whose history and current

financial statements showed the value

no longer to exist, Or on an

if once prudently made, or to maintain

the credit of a concern whose

securities already are impaired. The

due process clause ... has not and

cannot be applied to insure values or

restore values that have been lost by

the operation of economic forces.

324 U.S. at 567 (emphasis added).

el La ae eee

- 43 -

Finally, the principles of the due

process clause as applied in utility

rate-making cases were revisited in Permian

Basin Area Rate Cases 390 U.S. 747 (1968),

where this Court affirmed the practice of

the Federal Power Commission in setting

rates for natural gas by the area from

which it originated.12 Reiterating that

value may be constitutionally reduced, the

Court also recognized that regulation may

constitutionally “limit stringently’ the

return recovered on investment, for

investors' interests provide only one of

the variables in the constitutional

calculus of reasonableness." 390 U.S. at

769, again citing Sandford. 164 U.S. 578,

596 (1896). No constitutional objection

12 As a practical matter, individual rate

proceedings involving more than — 3300

producers was impossible. At the time of

the decision, 570 producers were involved

in 3,278 rate increase proceedings awaiting

hearing and decision. 390 U.S. at 757 nn.

12, 13.

- 44 -

existed where the commission weighed the

interests of individual producers (and

their investors) against the consumer

interests. 390 U.S. at 770.

This succession of cases illustrates

that regulators are allowed wide latitude

in determining the particular rates that

are “just and reasonable” for any given

area at any given time. Indeed, were this

not so, utilities would seek review on

Fifth Amendment grounds of every’ rate

decision where there was a cost denial. On

the contrary, as Hope made apparent, there

is no constitutional right to any specific

method of determining rates, nor is there

any constitutional right to inclusion of

any particular cost.

A number of state legislatures have

found the inclusion of costs that are not

used and useful in rate base to be an

‘ Pa a

oe as

;

a

i]

:

;

3

ao

9

«- @ «

unjust and unreasonable burde.. co place on

ratepayers. As noted in N j Vv w

York, price control is unconstitutional “if

arbitrary, discriminatory, or demonstrably

irrelevant to the policy the legislature is

free to adopt...." 291 U.S. at 539 #£=The

used and useful test is neither arbitrary,

discriminatory, nor irrelevant. Nothing in

Hope questioned tthe validity of this

criterion for consideration in

ratemaking. 13 Rather, that the reverse is

true is clear from Market Street. Simply

stated, there is no basis in the

Constitution for a utility's claim that the

cost of cancelled plant must be included in

rates.

13 See, e.g., Jersey Central Power Co. v.

Federal Energy Regulatory Commission,

F.2d 1168, 1175 (D.C. Cir. 1987) (en banc)

(The used and useful principle is one of

several permissible tools of ratemaking);

Washington Gas Light Co. v. Baker, 188 F.2d

ll (D.C. Cir. 1950), cert. denied 340 U.S.

952 (1951).

a @6 «

The long-range consequences of

allowing this due process attack. would be

to remove most of the risk from utility

investment. The Court would become, in

essence, a guarantor of utility

investments. This would be especially true

if the Court were to disallow the

application of the used and useful test.

Moreover, ratepayers are captive;

they must purchase a utility's product in

order to meet basic needs. Investors are

not captive. They may purchase stock in

any company and receive the applicable risk

premium for investments.

successful

Investors have been on notice for at least

the forty years since Hope that there is no

constitutional right to profits and that

the consumer

interests may outweigh

investor interests in any given case.

There is no need or reason to change that

firmly established principle now.

_

vid) totte e i ee

Cm ee et 0 DS Sah

‘

*

7

.

« “49 «

CONCLUSION

For the reasons

judgment of the

stated above, the

Supreme Court of

Pennsylvania should be affirmed.

Respectfully submitted,

STEVEN W. HAMM

Consumer Advocate

South Carolina

Co-Chairman

NASUCA's’ Electric

Committee

National Association

Of State Utility

Consumer Advocates

So. Carolina Depart.

of Consumer Affairs

2801 Devine Street

Post Office Box 5757

Columbia, SC 29250

(803) 734-9464

Dated June 30, 1988

RAYMON E. LARK, JR.*

Ass‘t Consumer

Advocate

Co-Chairman

NASUCA'S Electric

Committee

WILLIAM J. HERRMANN

Chief Counsel for

Illinois Governor's

Office of Consumer

Services

NASUCA Members

SUE A.HERRMANN

NANCY GAITSKILL

of Counsel

*Counsel of Record