Peoples Natural Gas Co. v. Pennsylvania Public Utility Commission ( 1943 )

The majority opinion has properly emphasized what we decided inSolar Electric Co. v. P.U. Comm., 137 Pa. Super. 325,335-6, 9 A.2d 447, viz., that in fixing the rate base of a utility the fair value of its property used and useful in the public service "is the thing which this commission and its predecessor were authorized by the legislature to ascertain". See Sec. 20 of Art. V of the Public Service Company Law of July 26, 1913, P.L. 1374, and sec. 311 of Art. III of the Public Utility Law of May 28, 1937, P.L. 1053, 66 P. S. § 1151, headed, "Valuation of Property of a Public Utility".

Notwithstanding the clear expression of our views in that case, which the commission, under the law, was required to follow until it was changed by this court, or reversed by our Supreme Court, the dissenting commissioner below refused to accept our construction of the Public Utility Law and, instead of Fair Value, insisted on using Book Cost less Depreciation Reserve as the rate base. This was in consequence of his erroneous conclusion that Section 310 of the Public Utility Law, relating to "Temporary Rates", which the commission was authorized to establish pending the final determination of the rate proceeding, and which provided that the temporary rates so fixed should "be sufficient to provide a return of not less than five per centum upon the original cost, less accrued depreciation, of the physical property (when first devoted to public use) of such public utility used and useful in the public service", furnished the rule to be applied in determining the rate base. If the legislature had meant this to be the measure of valuation in the final determination of a rate proceeding, it would have said so instead of prescribing "the fair value of . . . . . . the property of [the] public utility", as it did in the next section (311). It was only a temporary expedient — see Sec. 310(e) permitting the utility to amortize and recover the difference between the temporary rates and the rates as finally determined. And as pointed out in the majority opinion of this court, the constitutionality of section 310 has not been established by any decision of this court or of the Supreme Court of Pennsylvania, or by the Supreme Court of the United States. Its constitutionality did not come before the Supreme Court of the United States in Driscoll v. Edison Co., 307 U.S. 104, because, as there pointed out by Mr. Justice REED, the commission in fixing the temporary rates in that case had not strictly followed the rule laid down in section 310, but had also considered other matters proper to be considered in finally determining the rates. He said (p. 113) "The argument seems to be that a statute which permits an unconstitutional determination is invalid, even though it is actually applied in a constitutional manner . . . . . . as the district court had stated that compliance with Smyth v. Ames, [169 U.S. 466] was necessary in temporary rate making, the commission based the order now under review on evidence requisite under that rule. By taking this position, it interprets the statute as requiring consideration of elements other than original cost in fixing temporary rates."

While the commission did not adopt the view advanced by the dissenting commissioner, it, nevertheless, considered ``Book cost less depreciation reserve' as one of the elements proper for consideration in arriving at the rate base. The majority opinion in this court demonstrates that it has no place in such consideration and should be entirely disregarded in determining the rate base.

The dissenting opinion in this court, while not acceding to nor adopting the view of the dissenting commissioner, has nevertheless calculated the percentage of annual return that the commission's allowable income would give the utility, based on ``Book cost less depreciation reserve', plus working capital, ($9,869,793+$1,566,085) to be 12.25 per cent. In view of the fact that this calculation leaves out of consideration some $29,400,000, invested in the property of the utility, but carried on its books as Depreciation Reserve, I think it advisable that some further explanation of the nature of a Depreciation Reserve should be given.

Depreciation reserves are amounts set apart annually from income for the purpose of replacing the utility's property when worn out or discarded at the end of its useful life. The figure is calculated by ascertaining the amount which invested in good, safe securities, with the interest added annually, will be reasonably sufficient to replace the worn out plant, when its usefulness is over.

Expressed, from another point of view, "Depreciation is the loss, not restored by current maintenance, which is due to all the factors causing the ultimate retirement of the property. These factors embrace wear and tear, decay, inadequacy and obsolescence. . . . . . By [the ``straight line' method of computation], the annual depreciation charge is obtained by dividing the estimated service value by the number of years of estimated service life. The method is designed to spread evenly over the service life of the property the loss which is realized when the property is ultimately retired from service". HUGHES, C.J., in Lindheimer v. Illinois Bell Telephone Co., 292 U.S. 151,167, 168.

If the utility is a single structure, such as a concrete bridge, which does not call for enlargement or expansion, these annual depreciation reserves could be invested in government bonds, and the interest re-invested as it accrued, during the useful life of the bridge, and then, if like the Deacon's One-Hoss Shay, it went to pieces all at once, it could be replaced with a new bridge, out of the depreciation reserves, unless prices had materially increased by that time. In such case the reserve would be kept separate from the other moneys of the company and the interest received from it would be ear-marked and would not enter into the ordinary receipts and disbursements of the Company. But such an arrangement is not feasible for most utilities. Certainly not for one like this appellant with a plant consisting of many different items, with different life expectancies.

Consequently, in actual practice, these reserves for depreciation — especially as to items not replaceable for years — are often used in the enlargement and expansion and improvement of the utility, to the relief of additional capital expenditures; and they are entitled to have allocated to them their proportionate share of the income earned on the money so invested just as if the expansion and improvements had been paid for out of new capital raised by additional stock or bonds.

To say that such reserves are to be excluded from participating in the earnings to the extent that they have been invested in, and are now assets forming a part of, the used and useful property of the plant, would be to deprive the depreciation reserve of the income necessary to produce the amount required to replace the plant when its useful life is over.

In Clark's Ferry Bridge Co. v. P.S. Comm., 291 U.S. 227, which affirmed the judgment of this court (108 Pa. Super. 49,165 A. 261), Chief Justice HUGHES, speaking for the court, with reference to the depreciation reserve of a concrete bridge, said:

"There is no question as to the fact of depreciation. It was established, as respondent admits, that concrete bridges deteriorate from the moment of their completion; that there are chemical changes in their structure, absorptions of moisture and oxidation, both within the concrete and in the reenforcing iron covered by it, which cannot be stopped in their process or their effects removed. With this understanding, the question is as to the amount which should annually be allowed which will serve adequately to protect the investment from impairment due to age and use. Testimony was given by one of appellant's engineers that the average life of a concrete bridge was from 30 to 50 years; . . . . . . The Commission's engineer estimated its life at from 40 to 50 years; for his computation he took an expectancy of 45 years. Respondent urges that the annual allowance asked by appellant was plainly too large and contrasts it with appellant's claim for accrued depreciation. . . . . . While it is recognized that accrued depreciation, as it may be observed and estimated at a given time, and an appropriate allowance of depreciation according to good accounting practice, need not be the same, there is no rule which requires an allowance to be made or continued which in the light of experience is shown to be extravagant. . . . . . After reviewing the testimony, and the methods of calculation which the parties respectively advocated, the court [that is, this Court — see 108 Pa. Super. pp. 77, 78] thus stated its conclusion: "It [the Commission] allowed $7,678 annually. This sum set aside each year, with 4% simple interest will in fifty years produce approximately $767,800, sufficient to rebuild the bridge as now valued. The straight line method advocated by the Company will in fifty years with 4% simple interest produce a fund twice as great as that necessary to replace the bridge. The straight line method is often used for short-lived structures, or plants of a character that they can be restored from time to time to the original condition of efficiency. . . . . . It is not so fair or equitable when applied to a long-lived structure or one that is disintegrating gradually and continuously and not capable of being restored to its original condition. The company may not be required to apply the income received from the depreciation fund to make up any deficit of operation (Board of Public Utility Comm'rs v. NewYork Telephone Co., 271 U.S. 23), but it is not entitled to an allowance, which exclusive of interest earned on the fund, will be sufficient to rebuild the bridge, when its life is done, but only to such an allowance as will with reasonable interest added make a fund sufficient to replace the bridge when it requires replacement.'" (Italics supplied).

This principle was recognized in the Report of Committee on Depreciation, National Association of Railroad and Utilities Commissioners, 1943, cited in a note to the dissenting opinion in this court, which report, on page 168, says:

"It is sometimes said, and usually correctly, that assets represented by the depreciation reserve are plant assets. Such assets belong to the utility and, if used and useful in the public service, they are properly includible in the rate base. When it is argued that the depreciation reserve should be deducted in computing the rate base, it is not argued that the assets which it represents should be excluded from the base. It is argued, merely, that the depreciation reserve, when properly computed, represents the actual depreciation in those properties which are included in the base."

It is the fair value of the property of the utility, used and useful in the public service, which is the base to be used in determining what the utility is entitled to receive in a rate proceeding; not such property deprived of the assets purchased out of the funds of the company carried on its books as depreciation reserve.

The unfairness of a calculation based on such an exclusion of the utility's assets is best shown by a concrete example: If a utility has property used and useful in the public service, reasonably valued at thirty million dollars, with a depreciation reserve on its books of twenty-one million dollars invested in the plant, and its annual net income is $1,500,000, the rate of return is

1,500,000 1,500,000 5% — (that is, ---------- not 16 2/3%, ---------- ). The 30,000,000 9,000,000

same principle applies where earnings are not paid out in dividends but are plowed back into the expansion and improvement of the company's plant, and the earnings are thus, in effect, compounded. See Solar Electric Co. v. Penna. P.U. Comm., 137 Pa. Super. 325, pp. 352-3, 9 A.2d 447.