SFPP, L.P. v. Public Utilities Commission , 159 Cal. Rptr. 3d 10 ( 2013 )

Filed 6/13/13 SFPP v. Public Util. Com. CA4/3
NOT TO BE PUBLISHED IN OFFICIAL REPORTS
California Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or relying on opinions not certified for
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IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA
FOURTH APPELLATE DISTRICT
DIVISION THREE
SFPP, L.P.,
Petitioner,
v. G046669
PUBLIC UTILITIES COMMISSION, (Cal.P.U.C. Dec. Nos. 11-05-045,
12-03-026)
Respondent;
OPINION
CHEVRON PRODUCTS COMPANY
et al.,
Real Parties in Interest.
Original proceedings; petition for a writ of review of decisions of the
California Public Utilities Commission. Petition denied.
Mayer Brown, Donald M. Falk, Neil M. Soltman and Eileen Penner for
Petitioner.
Frank R. Lindh, Helen W. Yee and Pamela Nataloni for Respondent.
Baker Botts, Thomas J. Eastment, Gregory S. Wagner; Ropers, Majeski,
Kohn & Bentley and Susan H. Handelman for Real Parties in Interest BP West Coast
Products and ExxonMobil Oil Corporation.
Weber & Associates, George L. Weber; Orrick, Herrington & Sutcliffe and
Joseph M. Malkin for Real Party in Interest Chevron Products Company.
Dorsey & Whitney, Martha C. Luemers and Marcus W. Sisk, Jr., for Real
Party in Interest Phillips 66 Company.
Venable, Steven A. Adducci, Richard E. Powers, Jr., and Douglas C.
Emhoff for Real Parties in Interest Southwest Airlines Co., Ultramar Inc., and Valero
Marketing and Supply Company.
McGuireWoods and A. Brooks Gresham for Real Party in Interest Tesoro
Refining and Marketing Company.
I
INTRODUCTION
Petitioner SFPP, L.P. (SFPP) is a Delaware limited partnership that
operates both intrastate and interstate oil pipelines. SFPP’s upstream owners are Kinder
Morgan Energy Partners, L.P., a publicly traded partnership, which, through one of its
operating partnerships, Kinder Morgan Operating L.P. “D” (which itself is partly owned
by Kinder Morgan, Inc.) owns 99.5 percent of SFPP. The other .5 percent is owned by
Santa Fe Pacific Pipelines, Inc., a wholly owned, indirect subsidiary of Burlington
Northern Santa Fe Corporation.
Respondent Public Utilities Commission of the State of California (the
PUC) is the agency charged with regulating public utilities pursuant to Article XII of the
2
California Constitution and the Public Utilities Act,1 and accordingly, it regulates SFPP’s
intrastate pipelines.
Real parties in interest Chevron Products Company, Phillips 66 Company,
BP West Coast Products LLC, ExxonMobil Oil Corporation, Southwest Airlines Co.,
Tesoro Refining and Marketing Company, Ultramar Inc., and Valero Marketing and
Supply Company (collectively the Shippers) are oil companies and an airline operator
that use and pay for SFPP’s services on its pipeline facilities.
SFPP petitions for a writ of review of two of the PUC’s ratesetting orders,
specifically ARCO Prods. Co. v. Santa Fe Pacific Pipeline, L.P. (2011) Dec. No. 11-05-
045 [2011 Cal.P.U.C. Lexis 299] (SFPP I or the Final Decision), and the order on
rehearing, ARCO Prods. Co. v. Santa Fe Pacific Pipeline, L.P. (2012) Dec. No.12-03-026
[2012 Cal.P.U.C. Lexis 135] (SFPP II or the Rehearing Decision) (collectively the
Decisions). SFPP II granted limited rehearing, modified SFPP I in part, and denied
rehearing as to all other issues. (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *4.)
“The PUC is not an ordinary administrative agency, but a constitutional
body with far-reaching powers, duties and functions. [Citations.] The Constitution
confers broad authority on the PUC to regulate utilities, including the power to fix rates,
establish rules, hold various types of hearings, award reparations, and establish its own
procedures. [Citation.]” (Utility Consumers’ Action Network v. Public Utilities Com.
(2004) 120 Cal.App.4th 644, 654.)
The PUC’s jurisdiction “includes the authority to determine and fix ‘just,
reasonable [and] sufficient rates’ [citation] to be charged by the utilities.” (Southern
California Edison Co. v. Peevey (2003) 31 Cal.4th 781, 792.) The California Supreme
Court “has endorsed the commission’s position: ‘“The basic principle [of ratemaking] is
to establish a rate which will permit the utility to recover its cost and expenses plus a
1 Subsequent statutory references are to the Public Utilities Code unless otherwise noted.
3
reasonable return on the value of property devoted to public use.” [Citation.]’”
(Southern Cal. Gas Co. v. Public Utilities Com. (1979) 23 Cal.3d 470, 476.)
SFPP argues the PUC’s Decisions made two errors in its ratesetting orders.
First, SFPP2 argues the PUC erroneously denied it a federal income tax allowance
because it is a limited partnership instead of a corporation. SFPP strains mightily to
frame the PUC’s decision as one based on incorrect legal interpretations. It also argues
the Decisions are contrary to the PUC’s own factual findings, are an abuse of discretion,
and are in violation of due process. None of these arguments are supported by the record
and the relevant law. In essence, the PUC’s decision regarding the treatment of
partnerships for tax purposes is a policy question, and thus, not subject to reversal by this
court.
Second, SFPP claims the PUC set an unreasonably low return on equity,
arguing the PUC used a flawed methodology and failed to use a valid proxy group in its
rate calculations. We reject SFPP’s arguments on this point as unsupported by the
evidence and the Decisions, and conclude the PUC did not abuse its discretion in its
calculation of an appropriate return on equity.
II
RELEVANT FACTS AND PROCEDURAL BACKGROUND
The Decisions before us involve numerous consolidated proceedings dating
back to 1997. (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *2.) In the interests of
brevity, we do not detail the entire history of the proceedings, but only those parts
relevant to the issues before us.
2SFPP was previously named Santa Fe Pacific Pipeline, L.P., and is referred to as such in
many places in the record. (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *2.)
4
In 1991, SFPP sought a rate increase from the PUC for the first time since
1985. It was uncontested, and in 1992, the PUC granted SFPP a 9 percent increase. (In
re SFPP (1992) 44 Cal.P.U.C.2d 200 [1992 Cal.P.U.C. Lexis 499].)
In 1997, the Shippers filed a complaint with the PUC contesting SFPP’s
rates. (See ARCO Prods. Company v. SFPP, LP (1998) 81 Cal.P.U.C.2d 573 [1998
Cal.P.U.C. Lexis 593] (ARCO Prods. Company).) The Shippers asserted that because
SFPP was a limited partnership, it does not incur federal income tax liability and its net
income after taxes was identical to its net income before taxes. (Ibid.) SFPP conceded
“that it is a publicly traded partnership which itself incurs and pays no income tax and
that its affiliated corporate unitholders may incur no federal income tax liability on
income generated by defendant because of the availability of interest payment offsets
under a consolidated income tax return. However, defendant argues, the taxable income
that is generated by it as a partnership does not escape taxation: It is taken into income
by its partners.” (Ibid.)
Thus, initially, the PUC rejected the Shippers’ challenge, noting, with
respect to the tax allowance, that the 1992 rate setting was adopted “in full recognition
that defendant was organized as a limited partnership.” ARCO Prods. Company v. SFPP,
LP, supra, 1998 Cal.P.U.C. Lexis 593 at page 45. In 1999, however, the PUC granted
rehearing. (ARCO Prods. Company v. SFPP, LP (1999) 1 Cal.P.U.C.3d 418 [1999
Cal.P.U.C. Lexis 442] (ARCO Prods. Company Rehearing).)
ARCO Prods. Company Rehearing stated: “The Decision held that SFPP
should be allowed to include the $ 5.4 million ‘tax allowance’ in its expenses for
ratemaking purposes to prevent this result. This ‘tax allowance’ was calculated using the
corporate tax rate. Although there is logic to this approach, the Decision improperly
concludes that this approach must be adopted in order to comply with an established ‘tax
allowance policy.’ The Decision incorrectly reads Application of SFPP, L.P. (Increased
Transportation Rates) [D.92-05-018], supra, to establish such a policy. When we
5
approved SFPP’s 9% rate increase in 1992, we accepted a rate of return calculation that
included an expense item for taxes in the amount of $ 6,281,000. At the time, SFPP was
a master limited partnership that owned SFPP’s two predecessor pipelines. However,
Application of SFPP, L.P. (Increased Transportation Rates), [D.92-05-018], supra, was
decided on an ex parte basis and contains no discussion of tax questions. Thus, no
conclusion can be drawn from its determination that the total expense amount was
reasonable. We generally do not scrutinize applications that are not contested, and have
stated this policy explicitly in Re: Commission’s Rules of Practice and Procedure [D.95-
01-015] (1995) 58 Cal.P.U.C.2d. 480.” (ARCO Prods. Company Rehearing, supra, 1999
Cal.P.U.C. Lexis 442, at pp. *12-13.)
Thus, although the PUC believed “the use of a tax allowance is likely to be
permissible” the justification set forth in the 1998 case did not withstand scrutiny.
(ARCO Prods. Company Rehearing, supra, 1999 Cal.P.U.C. Lexis 442 at p. *13)
Rehearing was granted to consider tax issues and other matters. (Ibid.) Evidentiary
hearings were held in October 2000, but the PUC then left the matter undecided until
SFPP I. (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *1 [noting the Decision closes
C.97-04-025, the Shippers’ 1997 complaint].)
In 2001, SFPP proposed a surcharge to offset increases in power costs. The
request was approved, but the PUC directed SFPP to file an application to justify its
current rates. The Decisions at issue here address both the income tax allowance issue
raised by the Shippers’ 1997 complaint and the general rate application that SFPP filed at
the PUC’s direction.
The PUC issued SFPP I in May 2011. (SFPP I, supra, 2011 Cal.P.U.C.
Lexis 299 at p. 1.) As relevant here, the PUC decided that because SFPP is a partnership
that pays no income taxes, it is not entitled to an offset for income tax expenses. (SFPP
I, supra, 2011 Cal.P.U.C. Lexis 299 at pp. *18-37.) It also approved a return on rate base
of 10.40 percent, which included a return on equity of 12.61 percent. (Id., 2011
6
Cal.P.U.C. Lexis 299 at p. *48.) With respect to these issues, SFPP II denied SFPP’s
request for rehearing, although it was granted as to certain other issues not pertinent here.
(SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *4.)
III
DISCUSSION
A. Review of PUC Decisions
“‘[A]ny aggrieved party [to a decision of the Commission] may petition for
a writ of review in the court of appeal . . . .’ [Citation.] As here, when ‘writ review is the
exclusive means of appellate review of a final order or judgment, an appellate court may
not deny an apparently meritorious writ petition, timely presented in a formally and
procedurally sufficient manner, merely because, for example, the petition presents no
important issue of law because the court considers the case less worthy of its attention
than other matters.’ [Citation.] We are not, however, ‘compelled to issue the writ if the
[Commission] did not err . . . . [Citation.]” (Pacific Bell Wireless, LLC v. Public Utilities
Com. (2006) 140 Cal.App.4th 718, 728-729 (Pacific Bell Wireless).)
The limited grounds and standards for our review are set forth in section
1757, subdivision (a). “No new or additional evidence shall be introduced upon review
by the court. In a complaint or enforcement proceeding, or in a ratemaking or licensing
decision of specific application that is addressed to particular parties, the review by the
court shall not extend further than to determine, on the basis of the entire record which
shall be certified by the commission, whether any of the following occurred: [¶] (1) The
commission acted without, or in excess of, its powers or jurisdiction. (2) The
commission has not proceeded in the manner required by law. (3) The decision of the
commission is not supported by the findings. (4) The findings in the decision of the
commission are not supported by substantial evidence in light of the whole record. (5)
The order or decision of the commission was procured by fraud or was an abuse of
discretion. (6) The order or decision of the commission violates any right of the
7
petitioner under the Constitution of the United States or the California Constitution.”
Further, we cannot “hold a trial de novo, to take evidence other than as specified by the
California Rules of Court, or to exercise [our] independent judgment on the evidence.”
(§ 1757, subd. (b).)
“There is a strong presumption favoring the validity of a Commission
decision. [Citations.]” (Toward Utility Rate Normalization v. Public Utilities Com.
(1978) 22 Cal.3d 529, 537; see also City and County of San Francisco v. Public Utilities
Com. (1985) 39 Cal.3d 523, 530.) “Generally, we give presumptive value to a public
agency’s interpretation of a statute within its administrative jurisdiction because the
agency may have ‘special familiarity with satellite legal and regulatory issues,’ leading to
expertise expressed in its interpretation of the statute. [Citation.] Therefore, ‘the PUC’s
“interpretation of the Public Utilities Code should not be disturbed unless it fails to bear a
reasonable relation to statutory purposes and language. . . .” [Citation.] However . . . the
interpretation of statutes is a question of law subject to independent judicial review.
[Citation.]’ [Citation.]” (Pacific Bell Wireless, supra, 140 Cal.App.4th at p. 729.)
To the extent section 1757, subdivision (a)(4) is at issue, we use familiar
principles to review for substantial evidence. When an administrative agency’s
evidentiary findings are at issue, “The court must consider all relevant evidence in the
record, but ‘“[i]t is for the agency to weigh the preponderance of conflicting evidence
[citation]. Courts may reverse an agency’s decision only if, based on the evidence before
the agency, a reasonable person could not reach the conclusion reached by the agency.”’
[Citation.]” (Eden Hospital Dist. v. Belshé (1998) 65 Cal.App.4th 908, 915.)
When constitutional issues are raised, we exercise independent judgment on
the law and facts. (§ 1760.) Nonetheless, we may not substitute our own judgment “as to
the weight to be accorded evidence before the Commission or the purely factual findings
made by it. [Citations.]” (Goldin v. Public Utilities Commission (1979) 23 Cal.3d 638,
653.)
8
B. Income Tax Allowance
SFPP asserts the PUC “violated applicable law, abused its discretion, and
deprived SFPP of due process” by denying it an allowance for income taxes. SFPP
therefore claims the PUC’s decision on this point is subject to review under section 1757,
subdivision (a)(2)-(5). The PUC responds by pointing out that SFPP is a limited
partnership, and as such, pays no income taxes. Therefore, SFPP is not entitled to an
allowance for taxes it does not pay.
We briefly review the underlying basis for this dispute. The Internal
Revenue Code (IRC) treats corporations3 and partnerships differently for tax purposes.
Generally, corporations must pay tax “for each taxable year on the taxable income” of the
corporation. (26 U.S.C. § 11(a).) In addition to the income tax paid by a corporation,
taxes are also typically paid by shareholders who receive earnings distributions or
dividends from corporate income. (26 U.S.C. § 301,(a), (c); see SFPP I, supra, 2011
Cal.P.U.C. Lexis 299 at p. *20.) Partnerships, however, “shall not be subject to the
income tax imposed by this chapter. Persons carrying on business as partners shall be
liable for income tax only in their separate or individual capacities.” (26 U.S.C. § 701.)
For tax purposes, a partnership is “merely an agent or conduit through which the income
passed.” (United States v. Basye (1973) 410 U.S. 441, 448, fn. omitted.)
Thus, SFPP, as a partnership, does not pay income taxes. One of its
witnesses testified on this point before the PUC. Rather, its upstream partners (various
Kinder Morgan entities, for the most part) are allocated SFPP’s income and treated as if
they had generated it directly.
3Unless otherwise noted, the term “corporations” refers to “C” corporations rather than
“S” corporations.
9
The PUC’s practice is to calculate income tax allowances on a stand-alone
basis, without reference to corporate relationships such as holding companies, affiliates,
or subsidiaries. (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *22.) This policy
developed due to the increasing structural complexity of regulated utility entities and the
expansion of non-utility activities by subsidiaries. (Id., 2011 Cal.P.U.C. Lexis 299 at pp.
*22-23.) “Without the stand-alone treatment of the regulated entity, the non-utility
activities could result in a tax expense or savings unrelated to the costs of providing
utility service.” (Id., 2011 Cal.P.U.C. Lexis 299 at p. *24.) Thus, the PUC looks to the
tax liability of the utility alone in calculating any allowance.
As the PUC readily admits, utilities established as corporations, which pay
taxes, are entitled to receive an appropriate allowance to cover the tax expense. The
Final Decision stated: “SFPP should receive an appropriate allowance for income tax
expense, if it is liable for income tax. . . . SFPP has failed to demonstrate that there is a
corporate tax liability that should be recovered in rates. [¶] We only provide an
allowance where the utility expects to incur an expense. If, for example, SFPP were
suddenly able to conduct business entirely without paper, solely using electronic
communications, there would no longer be a need to purchase paper, ink, pens, postage,
storage boxes, file cabinets, etc. No one would reasonably argue that SFPP should still
have a theoretical allowance for paper and pens, and related items included in its expense
forecast. If there is no likely expense, there should be no expense forecast in rates. [¶]
[I]f there is no taxation on earnings while the earnings are still within the operating
control of SFPP, there is no income tax obligation to recognize as a utility operating
expense in rates.” (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at pp. *27-28, fn. omitted.)
At its essence, SFPP’s argument boils down to its claim that an income tax
allowance is required as a matter of law, while the PUC and the Shippers assert that it
10
was a policy choice made after an appropriate process. We address the components of
this argument below.4
1. The PUC’s prior decision
SFPP asserts the PUC’s “own established income tax doctrine” requires it
to grant partnerships an income tax allowance. SFPP relies heavily on a decision
involving it that we mentioned earlier, ARCO Prods. Company, supra, 1998 Cal.P.U.C.
Lexis 593 at page *45. In that case, the PUC rejected the Shippers’ complaint that an
income tax allowance was inappropriate for a limited partnership, noting the ex parte
ratesetting in 1992 was adopted “in full recognition that defendant was organized as a
limited partnership.” (Ibid.) SFPP claims the Decisions represent an “about-face”
without adequate justification. SFPP completely ignores the 1999 decision on rehearing,
ARCO Prods. Company Rehearing, supra, 1999 Cal.P.U.C. Lexis 442 at page *12.
The 1999 rehearing decision concluded that while there was logic in the
approach the PUC had taken in ARCO Prods. Company, the justification did not
withstand scrutiny. (ARCO Prods. Company Rehearing, supra, 1999 Cal.P.U.C. Lexis
442 at pp. *12-13.) Further, the PUC stated it needed “to consider the issue more
carefully” because it had no established policy in this area. (Ibid.) Rehearing prevented
the original decision from ever becoming final. (City of Los Angeles v. Public Utilities
Com. (1975) 15 Cal.3d 680, 707.) Thus, the Decisions do not represent a sudden
departure from over a decade of precedent, as SFPP suggests. The PUC had already
rejected its 1998 rationale in 1999.
4 While SFPP’s writ petition asserts seven different reasons the PUC erred on this point,
many of these arguments overlap and duplicate each other. Further, in its reply, it often
claims to be replying to arguments it claims the PUC made without citing to the PUC’s
brief. In the interests of convenience and avoiding repetition, we shall group similar
arguments together.
11
2. Competing authorities
SFPP correctly states that the Federal Energy Regulatory Commission
(FERC) and some state jurisdictions grant partnerships an income tax allowance on the
grounds that the tax paid by the partners is an operating cost. (See Policy Statement on
Income Tax Allowances (2005) 111 F.E.R.C. P61,139, 2005 FERC Lexis 1129; Suburban
Utility Corp. v. Public Utility Com. (Tex. 1983) 652 S.W.2d 358; Moyston v. New Mexico
Pub. Serv. Comm’n. (N.M. 1966) 412 P.2d 840; Home Tel. Co. v. State Corp. Comm’n.
(2003) 31 Kan.App.2d 1002; Washington Utilities & Transp. Com’n. v. Rainier View
Water Co. (July 12, 2002) 2002 Wash. UTC Lexis 323; In re Detroit Thermal, LLC
(Sept. 8, 2005) 2005 Mich. PSC Lexis 293; In the Matter of the Commission’s Generic
Evaluation of the Regulatory Impacts from the Use of Non-Traditional Financing
Arrangements by Water Utilities and Their Affiliates (Feb. 21, 2013) 2013 Ariz. P.U.C.
Lexis 58.)
We note, however, that a number of other jurisdictions have not permitted
income tax allowances for pass-through entities in the recent past. (See South Haven
Waterworks, Div. v. Office of Utility Consumer Counselor (Ind.Ct.App. 1993) 621
N.E.2d 653;5 Monarch Gas Co. v. Illinois. Commerce Com. (51 Ill.App.3d 1977) 366
N.E.2d 945; Penn. Public Utility Com. v. Jackson Sewer Corp. (Sept. 28, 2001) 2001 Pa.
P.U.C. Lexis 53; Farmton Water Resources LLC (Oct. 8, 2004) 2004 Fla. P.U.C. Lexis
5 SFPP claims this decision is “no longer good law,” but that is at best unclear. SFPP
cites to Petition of Hamilton Southeast Utilities, Inc. (Aug. 18, 2010) 2010 Ind. P.U.C.
Lexis 282. SFPP argues this opinion states “the South Haven decisions were explicity
predicated on an evidentiary failure, so that any legal holdings on the point were
therefore ‘dicta.’” First, we are unaware that a public utilities commission in any state
has the ability to declare that an appellate court decision is “no longer good law.”
Second, the commission only stated its own statements were “dicta,” not the court’s. (Id.,
2010 Ind. P.U.C. Lexis 282 at p. *62.) While the Indiana commission may have changed
its position, it would be equally supported by the law if it wished to deny an income tax
allowance.
12
863; Ridgelea Inv., Inc. (Oct. 14, 2008) 2008 Ky. P.U.C. Lexis 1259; Concord Steam
Corp. (Nov. 16, 1986, Order No. 18,484) 71 N.H. P.U.C. 667.)
We need not delve into the competing rationales at play here. Our only
concern is whether the PUC’s decision violated the law in some way which requires this
court to step in. (§ 1757.) Our review of these cases demonstrate competing policy
interpretations, but not, in contrast to SFPP’s argument, a legally compelled result in any
particular direction. Indeed, upon review of FERC’s decision to permit income tax
allowances to partnerships, the D.C. Circuit described the decision as including
“troubling elements,” yet deferred to FERC as a matter of policy. (ExxonMobil Oil Corp.
v. F.E.R.C. (D.C. Cir. 2007) 487 F.3d 945, 948.) “[P]olicy choices about ratemaking are
the responsibility of the Commission—not this Court. [Citation.]” (Id. at p. 953.)
Further, the fact that some states made their decisions before FERC’s
policy statement is not of particular import, as SFPP does not argue federal preemption.
While SFPP’s side of this argument may have more jurisdictions behind it at this point in
time, that is not particularly relevant, as policy decisions left to individual states are not
subject to a popularity contest.
SFPP has not demonstrated the law requires the PUC to grant partnerships
an income tax allowance, nor do we agree that the SFPP “arbitrarily” failed to address
FERC’s reasoning. The Decisions reflect the PUC was clearly aware of FERC’s different
policy choice on this point, and thus, the record does not support SFPP’s claim the PUC
arbitrarily and capriciously refused to consider FERC’s reasoning. Given that SFPP
vehemently disagrees, its remedy is with the legislature, and not, given our limited scope
of review, with this court.
3. The PUC’s understanding of the relevant law
SFPP argues the PUC’s decision was based on an erroneous view of the
law, lacked substantial evidence, and should therefore be vacated pursuant to section
13
1757. SFPP claims the decision “rests entirely on findings that are wrong as a matter of
governing federal tax law.” SFPP claims the PUC incorrectly concluded that the partners
incurred a personal income tax obligation only after the partnership distribution, which it
argues is untrue. Further, any income tax obligation accrues while the income is still in
control of the partnership.
Contrary to SFPP’s claims, the Final Decision reflects the PUC was aware
of the relevant income tax obligations. “SFPP itself does not directly pay tax on the
income it generates because SFPP is organized as a limited partnership. However, this
does not mean that income generated by SFPP is necessarily tax-free. SFPP’s income
could be eventually taxable in the hands of SFPP’s upstream owners, regardless of the
amount of cash SFPP actually distributes to them. The amount of tax paid on income
SFPP generates depends on the tax situation of each of its owners—including the
possibility that the tax obligation may be passed on to a further, indirect owner of SFPP.”
(SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *19.) In the Rehearing Decision, the
PUC repeated: “The Decision clearly shows that we did understand that SFPP’s partners
are responsible for any tax on its earnings.” (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135
at p. *7.) Rather, the PUC rejected SFPP’s preferred method of treating the partnership
as the tax-paying entity for purposes of setting rates. (Ibid.)
SFPP also argues that the stand alone doctrine, which, as we previously
noted, treats utilities as separate from any affiliates for ratemaking purposes, compels the
PUC to grant partnerships an income tax allowance. Arguing that the PUC has granted
allowances to corporations even if their parent pays taxes as part of a consolidated return,
SFPP argues this is no different from the tax a partner pays on SFPP’s income. As the
PUC accurately explains, however, this ignores that a corporate utility and its parent each
have a separate income tax liability. Thus, while a parent may pay the tax on a
consolidated return, the utility is still responsible for the tax separately. That is not true
14
of a partnership. We therefore disagree that the stand alone doctrine requires partnership
income tax allowances.
SFPP has not established that the PUC used “legally erroneous principles,”
in denying an income tax allowance; it would simply prefer a different policy.6 Indeed,
the Decisions show the PUC fully understood the relevant principles of federal tax law,
and applied two long-standing policies. First, as noted above, the PUC calculates income
tax allowances on a stand-alone basis, without regard to other related entities. (SFPP I,
supra, 2011 Cal.P.U.C. Lexis 299 at p. *22.) Second, to protect ratepayers, only
legitimate, actual expenses incurred by the utility are recognized as part of the ratemaking
process. (City and County of San Francisco v. Public Utilities Com. (1971) 6 Cal.3d 119,
129.) The PUC applied both of these principles in reaching its decision.
Similarly, we reject SFPP’s argument that the PUC abused its discretion
and based its decision on a misunderstanding of the economic consequences of denying
an income tax allowance to partnerships. To the extent SFPP’s argument on this point is
not conclusory, no “misunderstanding” is supported by the record.
4. Due Process
SFPP also contends it was denied a reasonable opportunity to develop an
evidentiary record on its actual or potential liability, and was therefore denied due
process. Specifically, it claims the PUC predicated its decision on an evidentiary
standard that did not exist until the Final Decision. This standard, also known as the
“FERC test,” refers to FERC’s requirement, established in its 2005 Policy Statement on
Income Tax Allowances, requiring partnerships to provide evidence of evidence of actual
6 We also reject SFPP’s argument that the PUC’s ruling conflicts with its own findings of
fact. This is another way of saying the PUC did not understand the law.
15
or potential taxes in order to calculate an income tax allowance, rather than relying on the
corporate tax rate.
While SFPP claims the PUC “endorse[d]” the FERC test, this is a
confusing assertion, given the PUC explicitly rejected the underlying policy that made
the FERC test relevant. As far as the PUC is concerned, the only “actual or potential” tax
liability that matters is federal income tax liability at the organizational level, of which
SFPP, as a partnership, has none. (26 U.S.C. § 701.) SFPP appears to be engaging in an
out-of-context reading of the Decisions to support this argument. For example, the Final
Decision mentions that “SFPP would fail the current FERC test on the record in this
proceeding,” (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *35) but that was not the
basis for the PUC’s decision. Rather, the Final Decision explicitly rejected the adoption
of FERC’s rule with regard to tax allowances for partnerships, noting: “In this instance,
we do not need our ratemaking determinations to match with FERC’s ratemaking,
because this Commission must also act within the scope of its discretion, and act
reasonably on its record.” (Id., 2011 Cal.P.U.C. Lexis 299 at p. *37.) Instead, it
concluded: “We find that SFPP does not have ‘an actual or potential income tax
obligation on the entity’s public utility income’ in addition to the personal tax obligation
of the partners after the partnership distribution.” (Ibid.)
On rehearing, the PUC made clear that policy, not a lack of evidence,
compelled its decision: “Because SFPP pays no income tax itself, the Decision found it
was not entitled to an income tax allowance for ratemaking purposes.” (SFPP II, supra,
2012 Cal.P.U.C. Lexis 135 at p. *6, fn. omitted.) “The Decision clearly shows that we
did understand that SFPP’s partners are responsible for any tax on its earnings. What we
rejected was SFPP’s suggestion that SFPP and its partners are one and the same.
Partnerships are viewed as ‘independently recognizable entities apart from the aggregate
of their partners’ for income tax purposes.” (Id., 2012 Cal.P.U.C. Lexis 135 at p. *7, fns.
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omitted.) Thus, given the PUC rejected the policy on which SFPP’s claimed assertion for
new evidence is based, its due process claim lacks merit.7
C. Return on Equity
SFPP next argues the PUC abused its discretion by setting an unreasonably
low rate of return on equity based on incorrect legal standards. While SFPP wanted a
return on equity of 15.86 percent, the PUC adopted a rate of 12.61 percent. The Shippers
recommended a rate of 12.28 percent. (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p.
*18.)
We begin by reviewing the relevant ratemaking principles. It is well-settled
that a utility is entitled to a reasonable return on its rate base, that is, “the value of the
property which it employs for the convenience of the public . . . .” (Bluefield Water
Works & Improvement Co. v. Public Serv. Comm’n. (1923) 262 U.S. 679, 692.) A
reasonable return is one which is “generally being made at the same time and in the same
general part of the country on investments in other business undertakings which are
attended by corresponding risks and uncertainties; but [the utility] has no constitutional
right to profits such as are realized or anticipated in highly profitable enterprises or
speculative ventures.” (Id. at pp. 692-693.) While the return on equity “should be
sufficient to provide a margin of safety for payment of interest and preferred dividends,
to pay a reasonable common dividend, and to allow for some money to be kept in the
business as retained earnings,” the PUC “must set the ROE at the lowest level that meets
the test of reasonableness.” (Application of Pacific Gas and Electric Company
(Cal.P.U.C. Nov. 7, 2002) 221 P.U.R.4th 501, 510 [2002 Cal.P.U.C. Lexis 718 at p. *27]
7 Moreover, as the Rehearing Decision notes, SFPP had the opportunity after FERC
issued its policy statement to present additional evidence to the administrative law judge,
but chose not to do so. (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *10.)
17
(PG&E); see also In Re Application of Pacific Gas and Electric Company (Cal.P.U.C.
Nov. 23, 1992) 46 Cal.P.U.C.2d 798 [1992 Cal.P.U.C. Lexis 798 at p. *161].)
“The Commission examines several cost components in calculating a utility
company’s revenue requirement. The Commission begins by determining the value of
the assets that the company has invested in to provide utility service . . . . This figure is
known as the ‘rate base.’” (The Ponderosa Telephone Co. v. Public Utilities Com. (2011)
197 Cal.App.4th 48, 51 (Ponderosa).) “To invest in rate base assets, a utility company
raises funds by either issuing debt or selling equity. Costs are associated with each
method. The company either has to pay interest to creditors on borrowed funds or pay a
portion of profits or dividends to equity investors, i.e., shareholders. This cost is known
as the cost of capital. The cost of capital, also known as the rate of return, multiplied by
the rate base is one component of the utility company’s revenue requirement.” (Ibid.) In
most instances, a mix of debt financing and equity is used. (Ibid.)
“The Commission determines a utility company’s cost of capital in a three-
step process. The Commission first adopts a reasonable capital structure, i.e., the
proportion of debt to equity that a utility company should use to finance its capital needs.
Next, the Commission calculates the company’s cost of debt, based on the actual cost of
the company’s outstanding debt during the most recent period. Third, the Commission
determines the appropriate return on the equity component of the utility company’s
capital by examining returns for businesses with comparable risks. Applying the
resulting figures to the adopted capital structure produces the weighted cost of capital.
This weighted cost of capital becomes the utility company’s authorized rate of return on
rate base.” (Ponderosa, supra, 197 Cal.App.4th at pp. 51-52.) Finally, “the Commission
determines the utility company’s rate base and multiplies that number by the authorized
rate of return. This figure is then added to the company’s operating expenses and tax
costs. The sum is the company’s revenue requirement, i.e., the amount needed to cover
the company’s costs and provide a reasonable return on its investments.” (Id. at p. 52.)
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In order to determine the numbers that go into the PUC’s analysis, several
financial models are used as a starting point. One of these is the discounted cash flow
(DCF) analysis. (PG&E, supra, 2002 Cal.P.U.C. Lexis 718 at pp. *24-25.) Although the
models themselves are subjective, the results depend on subjective inputs, which result in
a wide range of recommend returns. (Ibid; see also Application of California Water
Service Company (Cal.P.U.C. 2009) 272 P.U.R.4th 512, 524 [2009 Cal.P.U.C. Lexis 233
at p. *36].) “In the final analysis, it is the application of informed judgment, not the
precision of financial models, which is the key to selecting a specific ROE estimate. [A]s
we have routinely stated in past decisions, the models should not be used rigidly or as
definitive proxies for the determination of the investor-required return on equity.
Consistent with that skepticism, we find no reason to adopt the financial modeling of any
one party. The models are only helpful as rough gauges of the range of reasonable
outcomes.” (Ibid.)
According to SFPP I, the PUC adopted SFPP’s proposed capital structure
of 60 percent equity and 40 percent debt. (SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at
p. *48.) It also determined the cost of debt was 7.08 percent. (Ibid.) The PUC
concluded that “it is within our discretion, and within the recommended range, to adopt a
return of 12.61% on equity, which yields a weighted cost of capital for test year 2003 of
10.40%. The equity return is significantly higher than the rate adopted for the major
energy distribution utilities, and is slightly higher than the recommendation of
intervenors. When viewed with the 60% equity ratio, this return should be a sufficient to
compensate investors for the operating and financial risks associated with SFPP’s
operations.” (Id., 2011 Cal.P.U.C. Lexis 299 at pp. *48-49.)
The Final Decision also reflects that the return on investment recommended
by SFPP and the Shippers differed significantly, based on the financial model used.
(SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *47.) The PUC noted the
recommendations with approved returns on equity for four non-pipeline utilities, using
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2003 as a test period. (Id., 2011 P.U.C. Lexis 299 at pp. *42-49.) The compared returns
on equity ranged from 10.9 percent to 11.6 percent, returns lower than either SFPP or the
Shippers recommended. (Id., 2011 Cal.P.U.C. Lexis 299 at pp. *46-48.) The Final
Decision noted significant differences between SFPP, underscoring “the need to evaluate
rate of return on a case-by-case basis.” (Id., 2011 Cal.P.U.C. Lexis 299 at p. 47.) Using
the parties’ models as a “starting point” (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p.
*19), the PUC then “exercised our discretion to make pragmatic adjustments to the
recommended outcomes . . . .” (Ibid.)
Essentially, SFPP complains that the PUC did not use validly calculated
recommended returns on equity based on a valid proxy group with comparable risks.
First, it claims the PUC “erred in endorsing the Shippers’ proposed ROE as a valid lower
reference point, then closely adhering to that figure.” According to SFPP, the Shippers’
proposal was based on “discounted income” rather than “discounted cash flow.”
There is no evidence, however, that the PUC endorsed any specific
recommendation. As the Rehearing Decision stated: “DCF analyses are merely one tool
the Commission uses as a starting point to estimate a fair ROE. And all financial models
have certain flaws. For that reason, they are not rigidly applied or viewed as definitive
proxies to determine ROE. They are merely used to provide a rough gauge of the range
of reasonable outcomes.” (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at pp. *18-19, fn.
omitted.) The fact that the return on equity the PUC ultimately adopted was closer to the
Shippers’ recommendation than SFPP’s proves nothing.
Nor do we accept SFPP’s implication that there is only one acceptable DCF
methodology. As the PUC points out, even SFPP’s analysis used multiple variations.
Further, the law does not “‘bind rate-making bodies to the service of any single formula
or combination of formulas. Agencies to whom this legislative power has been delegated
are free, within the ambit of their statutory authority, to make the pragmatic adjustments
which may be called for by particular circumstances. . . .’ [Citations.]” (City of Los
20
Angeles v. Public Utilities Com., supra, 15 Cal.3d at p. 698.) We must therefore reject
SFPP’s argument on this point.
Second, with respect to the appropriateness of the proxy group, SFPP
contends the PUC either used an inappropriate group or none at all. As noted above,
utilities are usually entitled to earn a return similar to those of other companies having
similar business risks. (Bluefield Water Works & Improvement Co. v. Public Serv.
Comm’n., supra, 262 U.S. at pp. 690, 692.) Companies used for such comparisons are
referred to as proxy groups. SFPP argues the PUC either considered an inappropriate
proxy group or none at all.
The record does not support this conclusion. With respect to the claim the
PUC used an inappropriate comparison group of non-pipeline utilities, the Rehearing
Decision clarifies that is not what occurred. “SFPP is wrong that the Decision relied on a
proxy group of energy utilities for purposes of the ROE analysis. We did generally note
the authorized ROEs for Pacific Gas and Electric Company, Southern California Edison
Company, San Diego Gas & Electric Company, and Sierra Pacific Power Company
during the same 2003 time frame. However, we specifically stated that the differences
between SFPP and energy utilities required that we evaluate authorized returns on a case-
by-case basis.” (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *16, fns. omitted.)
Thus, SFPP’s argument that these companies were used as a proxy group is incorrect.
If that is not the case, SFPP claims, then the PUC used no proxy group at
all, which is equally problematic. But this, too, is unsupported by the record. Both SFPP
and the Shippers agree they used the same proxy group of five publicly traded oil
pipelines in their own DCF analyses. As the Rehearing Decision noted, the PUC
“reviewed the DCF analyses presented by both parties . . . .” (SFPP II, supra, 2012
Cal.P.U.C. Lexis 135 at p. *19.) Thus, the Shippers argue, and we agree, the PUC
necessarily considered this group “to provide a rough gauge of the range of reasonable
outcomes.” (Ibid., fn. omitted.) We must therefore reject SFPP’s contention that the
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PUC relied on no proxy group at all. The fact that the PUC did not discuss the proxy
groups at length is not evidence it did not consider them.
Further, as the PUC stated, “It is also relevant to note that this Commission
regulates very few oil pipeline companies that we can look to for comparison purposes.”
(SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *16.) While SFPP criticizes this
statement and urges the PUC to draw from “public information” about other pipelines in
what it considers to be a valid proxy group, there is no legal requirement for the PUC to
do so. As the PUC points out, “Nothing in the record provided a meaningful factual
comparison or analysis of the relative risks and uncertainties of those entities.”
Finally, a proxy group is just one element of many the PUC considers in
setting rates. There is no support in the record that the PUC abused its discretion in doing
so here.
IV
DISPOSITION
The petition for writ of review is denied. Respondent and real parties in
interest are entitled to their costs on appeal.
MOORE, ACTING P. J.
WE CONCUR:
ARONSON, J.
THOMPSON, J.
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