Central Maine Power Co. v. Public Utilities Commission , 1983 Me. LEXIS 592 ( 1983 )

WATHEN, Justice.

On June 29, 1981, Central Maine Power Company (“CMP”, “Company”) filed with the Commission proposed new rate schedules pursuant to 35 M.R.S.A. § 64 (Supp. 1982-83). The proposed rates were designed to produce a net increase in annual operating revenues equal to 15.3%, or $55,-000,000, based upon a 1981 test year.

After extensive public hearings, the Commission entered its Decision and Order on March 27,1982. That Order disallowed and rejected the schedule of proposed rates filed by CMP and authorized the Company to file a substitute rate schedule designed “to increase test year gross revenues on an across-the-board basis by no more than $31,-895,000.” Pursuant to the Commission’s Decision and Order, CMP filed substitute rate schedules, and these schedules were approved by Supplemental Order No. 1, dated April 9, 1982.

CMP, pursuant to 35 M.R.S.A. § 303 (1975), has appealed from both the Commission’s Decision and Order and Supplemental Order No. 1. In addition, CMP filed a Complaint with this Court pursuant to 35 M.R.S.A. § 305 (1977).

On appeal, the Company challenges the Decision and Order, together with the Supplemental Order, and contends that the Commission erred in determining the cost of equity, the allowance for attrition, working capital requirements and in refusing to allow the inclusion of certain advertising expense for ratemaking purposes. We sustain the Commission’s order in all respects.

I. Cost of Equity.

In the present case in calculating the rate of return, the Commission found that CMP’s cost of equity fell within a range of 15.4% to 15.6%, and assigned a cost of 15.4% to the Company’s common equity. The Company, while not disputing the reasonableness of that range, argues that 15.4% is arbitrary, unreasonable, unlawful and confiscatory of its property in violation of the United States and Maine Constitutions. It asserts that the Commission, in essence, imposed a $500,000 “penalty” on CMP, by setting its cost of equity at the low end, rather than the middle, of the established range of reasonableness, and that it did so on the basis of alleged deficiencies in the Company’s policies and management practices» with respect to cogeneration and conservation.¹ CMP argues that the record does not support the finding of a deficiency in Corn-pany policy and that in any event the imposition of a “penalty” constitutes error as a matter of law.

The determination of an appropriate rate of return is an essential function of the Commission in the ratemaking process. The rate of return is designed to provide sufficient revenue to cover the Company’s total cost of service. Such costs include both the operating expenses of the utility and an adequate “return” on the investment in property and equipment serving the public. See New England Telephone & Telegraph Company v. Public Utilities Commission, Me., 448 A.2d 272,284 (1982), (hereinafter “1982 NET Case”).

In determining what constitutes a just and reasonable rate, this Court has relied upon two leading decisions by the United States Supreme Court:

A public utility is entitled to such rates as would permit it to earn a return on the value of the property which it employs for the convenience of the public equal to that 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 it has no constitutional right to profits such as are realized or anticipated in highly profitable enterprises or speculative ventures.

Bluefield Water Works & Improvement Company v. Public Service Commission, 262 U.S. 679, 692-3, 43 S.Ct. 675, 678-679, 67 L.Ed. 1176 (1923) quoted in New England Telephone and Telegraph Company v. Public Utilities Commission, Me., 390 A.2d 8, 31 (1978) (hereinafter “1978 NET Case”).

We held in Federal Power Commission v. Natural Gas Pipeline Co., [315 U.S. 575, 62 S.Ct. 736, 86 L.Ed. 1037 q1942)], supra, that the Commission was not bound to the use of any single formula or combination of formulae in determining rates. Its ratemaking function, moreover, involves the working of “pragmatic adjustments.” ... And when the Commission’s order is challenged in the courts, the question is whether that order “viewed in its entirety” meets the requirements of the Act. ... Under the statutory standard of “just and reasonable” it is the result reached not the method employed which is controlling. ... It is not theory but the impact of the rate order which counts. If the total effect of the rate order cannot be said to be unjust and unreasonable, judicial inquiry under the Act is at an end. The fact that the method employed to reach that result may contain infirmities is not then important. Moreover, the Commission’s order does not become suspect by reason of the fact that it is challenged. It is the product of expert judgment which carries a presumption of validity. And he who would upset the rate order under the Act carries the heavy burden of making a convincing showing that it is invalid because it is unjust and unreasonable in its consequences, (citations omitted) (emphasis added)

Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591, 602, 64 S.Ct. 281, 287-288, 88 L.Ed. 333 (1944), quoted in 1978 NET Case, 390 A.2d at 31-32.

One facet of the method employed by regulatory agencies to determine the fair rate of return, and one which was used in this case, is an analysis of the utility’s cost of equity. The cost of equity is an expression of what the utility must earn (stated in percentages) in order to secure necessary financing from equity investors. 1978 NET Case, supra, at 32. As to this task, this Court recently noted that:

Determining the cost of equity is one of the more difficult computations in the rate-making process. The Commission must concern itself with many economic variables and evaluate conflicting evidence interpreting and applying those variables. Because of the complexity of the task, the Law Court necessarily defers to the regulatory expertise of the Commission if the Commission’s decision is supported by substantial evidence. We do not attempt to second-guess the Commission on matters falling within its realm of expertise. Our review is limited to determining in the light of the record whether the Commission’s conclusions are unreasonable, unjust or unlawful. The utility has the burden of proving that the Commission has erred. 35 M.R.S.A. § 307 (1978).

1982 NET Case, 448 A.2d at 287-88.

Again, the Company does not challenge the inherent reasonableness of the 15.4% — 15.6% range adopted by the Commission in this case with respect to its cost of equity. Rather, CMP asserts that the Commission adopted the range of reasonableness “as part of an attempt to insulate the unsupported penalty from judicial review.” We have previously recognized, however, that ratemaking is an “inexact science” and, accordingly:

The concept of a “just and reasonable” rate does not signify a particular single rate as the only lawful rate but rather encompasses a range [of reasonableness] within which rates may be deemed just and reasonable both in terms of revenue level and rate design. It is within the sound discretion of the Commission to fix the exact level and design within that range.

Central Maine Power Company v. Public Utilities Commission, Me., 382 A.2d 302, 327-28 (1978). See also Central Maine Power Company v. Public Utilities Commission, Me., 405 A.2d 153, 182 (1979). Moreover, since this Court’s review is limited to the “result reached and not the method employed” (Hope Natural Gas Co., supra), it should not disturb the Commission’s result so long as the cost of equity allowed is within a range of reasonableness supported by sufficient evidence.

On review, we find substantial evidence to support the Commission’s position. Before adopting the range of 15.4% to 15.6%, the Commission heard extensive testimony bearing on CMP’s cost of equity. The estimates given in testimony, based upon various methods, ranged from 13.43% to 18.125%.

The Company nevertheless argues that since the Commission would have assigned a 15.5% cost of capital but for its alleged infirmities with respect to conservation and cogeneration, the Commission’s decision, pursuant to 35 M.R.S.A. § 51 (1975),² to lower CMP’s cost of capital to 15.4% must fail. It is not necessary to determine in this case, however, whether the Commission upon an adequate record may properly “penalize” a utility pursuant to section 51 for such reasons as the failure to effectuate the public policy expressed in independent state and federal energy legislation.³ The Commission’s determination of CMP’s cost of equity in this case is independently supported by the record and falls within a range we find to be reasonable. Accordingly, we must uphold the Commission’s decision as a proper exercise of discretion. 1982 NET Case, 448 A.2d at 278.

II. Attrition.

The order of the Commission includes an attrition allowance of .05% or $672,000. The Company claims that result to be erroneous. It is asserted that the evidence compels an allowance equal to .60%, or approximately $8,000,000, in order to provide a fair rate of return. The substantial discrepancy results solely from the Commission’s inclusion of Construction Work in Progress (“CWIP”) and the associated Allowance for Funds Used During Construction (“AFUDC”), in computing the attrition allowance. It is the Company’s position that the inclusion or “growth” of CWIP and AFUDC in attrition is error as a matter of law and that in this instance the Commission acted arbitrarily and unreasonably. While no authority is cited, the argument is advanced that the methodology employed in calculating attrition is antithetical and self-defeating.

Allowance for attrition is an accepted ratemaking procedure designed to assure a fair rate of return. This Court has long recognized that the inflexible use of the historic test year could result in an erosion of the rate of return. In appropriate cases we have approved the use of an attrition allowance and have looked with favor upon attempts to enhance the accuracy of the forecast:

[W]e know with the maximum degree of certainty attainable in a forecast that in the period for which rates are to be set there will be an increase in net expense. To ignore this probability is to defeat the very idea of fixing rates for the future upon intelligent and informed estimates. Why should a probability such as this be set aside in favor of the experience of the test year, which we know with a certainty will not be repeated in the future? The experience of the test year is at best a “guess” for the future. If we can make the “guess” more in line with the probability, in the long run we will have benefited both public and Company.

Central Maine Power Co. v. Public Utilities Commission, 153 Me. 228, 236, 136 A.2d 726, 732 (1957). We have noted that “[attrition, the tendency of the actual rate of return to diminish, has been said to result from two factors: —(1) steadily increasing construction costs, and (2) calculation of the rate of return in the year prior to that for which the return is calculated” Central Maine Power Company v. Public Utilities Commission, Me., 382 A.2d 302, 316, n. 16 (1978).

There can be little dispute that an attrition adjustment is appropriate where supported by record evidence. It is the responsibility of the Commission, in the first instance, however, to weigh the evidence in determining the demonstrated need for such an allowance and to select an appropriate methodology for computation. 1978 NET Case, 390 A.2d at 49; Central Maine Power Company v. Public Utilities Commission, Me., 382 A.2d 302, 317 (1978).

The inquiry is complicated by the inclusion of the concepts of CWIP and AFUDC in the methods employed to calculate attrition. This Court has previously addressed these accounting concepts in the context of inclusion in rate base, but has not had prior occasion to consider their inclusion in an analysis of attrition.⁴

The facts of this case demonstrate that increased investment in construction produces substantial difficulty in determining rates. Section 51 mandates a fair rate of return and one which is sufficient to maintain the financial integrity of the Company. The Commission included CWIP and AFUDC in the attrition adjustment in an effort to balance the interests of the ratepayer and those of the investor. Contrary to the assertions of CMP, a claim of error in this regard is not resolved by fashioning an abstract proposition of law which confirms or denies the inclusion of CWIP and AFUDC. The Commission’s decision must rest or fall upon the adequacy of its factual finding that a need for a greater attrition allowance has not been demonstrated. In Central Maine Power Company v. Public Utilities Commission, Me., 433 A.2d 331 (1981), for example, we concluded that the choice between a gross or net rate of capitalization for AFUDC was well within the discretion of the Commission and we noted that “[a]t bottom, that decision rests on the Commission’s factual finding that ‘a shift [from gross to net capitalization rate] is not now essential to the Company’s financial integrity.’ ” Id. at 343.

Commission orders from other jurisdictions demonstrate that the treatment of CWIP and AFUDC is totally dependent upon the facts of the particular case. Under certain circumstances, as investment in construction impinges on cash flow, it has been necessary to permit a return on utility property not yet ready for service. There are several examples of the inclusion of CWIP in rate base without offset by AFUDC. See, e.g., Re Public Service Company of Colorado, 41 PUR 4th 225, 238 (Colo.P.U.C.1980); Re Tampa Electric Company, 39 PUR 4th 553, 559 (Fla.P.S.C.1980).

When dealing with either rate base or attrition, the appropriateness of inclusion or exclusion of CWIP and AFUDC is determined by the evidence contained in the record. The record in this case adequately supports the conclusion of the Commission that an attrition allowance of .05% is sufficient to maintain the financial integrity of the Company.

III. Offset of Accrued Interest on Debt and Accrued Dividends on Preferred Stock to Working Capital Allowance.

The Commission ruled that accrued but unpaid interest on debt, and accrued but unpaid dividends on CMP’s preferred stock, be treated as consumer-supplied capital and used to offset or reduce the Company’s working capital requirement. As a result, the Company’s working capital requirement, and therefore its rate base, was reduced by a net figure of $3,766,000.⁵

An allowance for working capital is a ratemaking practice whereby the utility’s rate base is adjusted to reflect those investor-supplied funds that “may be required by the utility to meet its day-to-day operating expenses.” 1978 NET Case, 390 A.2d at 51. An essential part of this allowance is the cash advanced portion of working capital which has been defined as “the amount of cash required to operate a utility during the interim between the rendition of service and the receipt of payment therefore.” Id., quoting City of Pittsburgh v. Pennsylvania Public Utility Commission, 370 Pa. 305, 309, 88 A.2d 59, 61 (1952).

The most common method for determining the cash advanced portion of working capital is the so-called “lag” analysis which measures the number of days between payment of operating expense by the utility and collection of revenue from customers. When applied to components of expense, the days of cash lag yield the amount of money required to be put forth by investors for Company operations.

In this case a lag analysis was presented by both Mr. Stevenson, a Company witness, and Mr. Louiselle, a Staff witness, to compute the cash advanced portion of working capital. Although the two witnesses were in substantial agreement, Mr. Louiselle made an adjustment beyond those suggested by Mr. Stevenson to reflect the effect on working capital of accrued interest on debt and accrued dividends on preferred stock.⁶ His reasoning was as follows:

Interest on [long-term] debt is paid semiannually while it is collected from customers through rates on a monthly basis. Since this lag exceeds the revenue lag, the Company has interest funds available for working capital purposes that are provided by customers. It must be stressed that these funds are not investor-provided funds, but rather, customer provided .... To disregard the effect of the lag in interest payments simply ignores reality and results in an overstatement of the rate base.

The Commission adopted Mr. Louiselle’s analysis.

This Court has recognized that in determining the need for working capital, “the Commission may quite reasonably and properly take into account factors which reduce the need [for working capital] as well as those which increase it.” 1978 NET Case, 390 at 51, quoting Alabama-Tennessee Natural Gas Co. v. Federal Power Commission, 203 F.2d 494, 498 (3d Cir.1953).

The Company seeks to distinguish the subject adjustment by asserting that “interest on debt and preferred stock dividends are capital, below the line items which have nothing to do with the cost of day-to-day operations for which working capital must be provided.” It argues that the Commission erred as a matter of law and that ratepayers have no claim on those funds to support an offset to working capital requirements.

The Commission does not argue here that capital costs should be reflected in working capital. Rather, it argues that the investors should receive a return only on that portion of working capital actually contributed by investors, and that to accomplish that result it is necessary to offset accrued funds collected from customers in advance of payment. The position of the Commission is supported by the weight of authority, see, e.g., Pacific Telephone and Telegraph Co. v. Public Utilities Commission, 62 Cal.2d 634, 662, 44 Cal.Rptr. 1, 19, 401 P.2d 353, 371 (1965); Washington Utility and Transportation Commission v. Pacific Northwest Bell Telephone Co., 39 PUR 4th 126 (Wash. Util. & Trans. Comm’n. 1980); Pennsylvania Public Utilities Commission v. Metropolitan Edison Corp., 28 PUR 4th 555 (Pa. PUC 1979); Re: Iowa Public Service Co., 10 PUR 4th 467 (Iowa State Com. Comm’n. 1975). We find the Commission approach to be a reasonable means of assuring a fair return on working capital supplied by investors. To accept the Company’s position would be to exalt form over substance.

IV. Reduction of Working Capital With Respect to Contractor Retentions.

The record reflects that the Company typically withholds a portion of payments due contractors on various construction projects until after completion of the particular project. Because these retentions provide CMP with a source of non-investor supplied capital, they are offset against the Company’s working capital allowance. CMP does not contest the Commission’s discretion to offset such retentions against working capital. It does argue, however, that the $1,002,000 reduction to working capital made by the Commission in this case was not justified or supported by record evidence.

The evidence showed that during the test year CMP had an average balance of contractor retentions of $1,002,000. Except for $20,000, the retentions resulted from two hydro projects which were both completed shortly after the test year ended. The Company claims that because all but $20,-000 was in fact paid soon after the end of the test year, the test year retention levels were no longer representative. It is contended that an adjustment for a “known” change is necessary in determining a current offset to working capital.

In support of its position, CMP relies upon Central Maine Power Company v. Public Utilities Commission, 153 Me. 228, 236, 136 A.2d 726, 732 (1957), where the Law Court recognized that “[t]he experience of the test year is at best a ‘guess’ for the future. If we can make .the ‘guess’ more in line with the probability, in the long run we will have benefited both public and Company.” Accordingly, CMP argues that the Commission should not limit itself to the Utility’s experience during any single year “when such a limitation would produce an inaccurate assessment of [the Company’s] true financial situation.” Mars Hill and Blaine Water Co. v. Public Utilities Commission, Me., 397 A.2d 570, 576 (1979).

The test year experience, however, should not be rejected except upon a “strong showing of its weakness as a measure for the future.” Central Maine Power, 153 Me. at 239. As this Court recently noted:

A basic assumption of the test-year concept is that, over all, the test year is representative of the foreseeable future. The elements that go into the test-year computations of income and expense are not scrutinized individually to determine the degree of likelihood that particular items will recur or disappear or change in the relatively near future. To permit such scrutiny would be to make the test year concept unworkable as a device for prediction of new revenues.

1982 NET Case, 448 A.2d at 294.

In the present case, in assessing the proper offset to working capital, the Commission relied principally on the testimony of Staff witness Louiselle, who testified as to the propriety of deducting the entire test year amount from the rate base:

The point is that test year retentions will be superseded by other retentions in the normal course of business. ... The test year has as its goal the determination of the various components such that the relationships are reasonably indicative of the future. The fact that the dollars associated with a particular component will cease to exist is in part irrelevant if the overall relationships remain in balance or if those dollars are replaced with similar amounts.

Moreover, because the record reflects that CMP’s projected construction program assumed significantly increased expenditures, the Commission was warranted in concluding that retained funds remain at the same level.

CMP, in turn, failed to introduce any evidence before the Commission sufficient to establish that the test year experience was not indicative of the utility’s expected contractor retention balance for the present rate year. Although the retentions associated with two specific hydro projects would no longer be reflected in the Company’s balance, CMP did not put forth evidence which could establish the likelihood of known and measurable changes from the overall test year data. The mere fact that the Company paid out a substantial portion of its test year retentions, does not amount to a “strong showing” that that amount will not be replaced by similar levels in the future. The Commission’s reduction of working capital by $1,002,000 was reasonable.

V. Disallowance of the Costs of CMP Television Advertisements.

The Company argues that the Commission acted arbitrarily and capriciously, in violation of its own regulations, in excluding the $67,798 cost of four CMP television advertisements as test year expenses for ratemaking purposes.

The Commission’s Regulations (Me.P.U.C. Reg. Ch. 83) establish various categories for advertising and political activities and set forth the ratemaking and accounting treatment for each. Chapter 83 requires that all expenses associated with “institutional” or “promotional” advertising be separately accounted for (§ 3) and states that “no electric or gas utility shall recover from any persons other than its shareholders or other owners for any expenditures, contributions, expenses, or costs of such utility incurred with respect to institutional advertising .... ” § 5(c).⁷ The rule excepts from the general prohibition certain types of institutional advertising, which in relevant part are as follows:

(1) Inform customers how they can conserve energy, reduce peak demand for a utility’s service or otherwise reduce consumption of the utility’s service,

(2) Inform customers about energy-efficient appliances, equipment or services, or about practices which reduce the cost of utility service,

(4) Concern connection, disconnection, conditions of service, billing procedures, service interruptions, safety measures, or emergency conditions.

Section 1(F).

CMP does not challenge the validity of the regulation, but maintains that the four disputed advertisements fall within the above exceptions. The allowance or disallowance of institutional advertising as a ratemaking expense is inherently a policy decision, and therefore a matter properly within the Commission’s discretion. Cf. 1978 NET Case, 390 A.2d at 55-6. Whether a particular advertisement falls within one of the established exceptions and should be included in the Company’s operating expenses for ratemaking purposes, therefore, becomes a question of fact for the Commission. Again, the Commission’s findings of fact are final if supported by substantial evidence in the record. 1982 NET Case, 448 A.2d at 278.

On review, we find that the Commission could reasonably have concluded that the advertisements in issue are little more than recitals of CMP’s internal efforts with respect to safety and conservation programs. It would be reasonable to conclude that the advertisements were not designed to provide the type of consumer information specified in the regulation.

The Company argues that the Commission erred in construing Chapter 83 § 1(F) as being limited in scope to equipment, practices and services in which the customer can engage. It maintains that section 1(F) refers to any such equipment, practices or services and necessarily encompasses the practices of a utility. The interpretation of regulations by the agency that promulgated them, however, is entitled to great weight and should not be set aside unless clearly erroneous. See, e.g., Walters v. Petrolane-Northeast Gas Service, Inc., Me., 425 A.2d 968, 972-73 (1981). Moreover, if the exceptions of section 1(F) are to make any sense in light of the general prohibition against passing the costs of institutional advertisements through to ratepayers, it would certainly be reasonable to conclude that they refer only to information, services or equipment that in some way can be expected to have a direct benefit to the ratepayer. Accordingly, we uphold the disallowance of the costs of these television advertisements for ratemaking purposes.

The entry is:

Section 303 appeal denied.

Judgment for defendant in section 305 complaint.

The Decision and Order and the Supplemental Order of the Commission is affirmed.

GODFREY, VIOLETTE, JJ., and DU-FRESNE, A.R.J., concurring.

1 . In its Order and Decision, the Commission noted:

[i]f it were not for CMP’s practices with respect to cogeneration and conservation, we would allow CMP a rate increase designed to provide it with a reasonable opportunity to earn a return of 15.5% on its common equity. However, for the reasons set forth below, we find that with respect to the promotion of conservation and cogeneration, the Company has not been operating as efficiently as possible nor has it been utilizing sound management practices. 35 M.R.S.A. § 51. Therefore, we will allow CMP a rate increase designed to provide it with a reasonable opportunity to earn a return of 15.4% on common equity.

2 . 35 M.R.S.A. § 51 states in relevant part:

In determining just and reasonable rates, the commission may consider whether the utility is operating as efficiently as possible and is utilizing sound management practices.

3 . E.g., the Electric Rate Reform Act, 35 M.R.S.A. §§ 92-96 (1981-82 Supp.); the Public Utility Regulatory Policies Act of 1978 (PURPA), 16 U.S.C.A. §§ 2601-2645 (Supp. 1982), and the Small Power Production Facilities and Cogeneration Facilities Act (SPPFA). 35 M.R.S.A. §§ 2321-2328 (1979).

4 . For purposes of determining rate base a matching principle is employed which typically results in CWIP being offset by AFUDC. See Central Maine Power Company v. Public Utilities Commission, Me., 433 A.2d 331, 342 (1981).

5 . The Commission decreased working capital by $3,820,000 to reflect the net lag on long-term and short-term debt interest and increased working capital by $54,000 to reflect the negative net-lag associated with preferred stock dividends.

6 . The Company’s revenue lag was computed at 47 days. The payment of interest on long-term and short-term debt was at 90 and 45 days respectively. The lag on the payment of preferred stock dividends appears from the record to have been 45 days.

7 . “Institutional advertising” is defined as “any advertising conducted for the purpose of promoting the corporate image or good will of a public utility or the utility industry.” Section 1(c).