# Amicus Curiae Brief — Duquesne Light Co. v. Barasch

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 1989
- **Citation:** 488 U.S. 299

## Text

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

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385012_0631%3A12. Public record. Not legal advice.