Residential Utility Consumer Office v. Arizona Corporation commission/arizona Water Company

IN THE
SUPREME COURT OF THE STATE OF ARIZONA
RESIDENTIAL UTILITY CONSUMER OFFICE, AN AGENCY OF THE STATE OF
ARIZONA,
Appellant.
v.
THE ARIZONA CORPORATION COMMISSION,
Appellee,
ARIZONA WATER COMPANY,
Intervenor.
No. CV 15-0281-PR
Filed August 8, 2016
Arizona Corporation Commission
Nos. W-01445A-11-0310
W-01445A-12-0348
AFFIRMED
Opinion of the Court of Appeals, Division One
238 Ariz. 8, 355 P.3d 610 (App. 2015)
VACATED
COUNSEL:
Steven A. Hirsch (argued), Rodney W. Ott, Quarles & Brady, LLP, Phoenix,
Attorneys for Intervenor Arizona Water Company
Wesley C. Van Cleve (argued), Janet Wagner, Maureen A. Scott, Arizona
Corporation Commission, Phoenix, Attorneys for Arizona Corporation
Commission
Scott S. Wakefield, Hienton & Curry, P.L.L.C., Phoenix; and Daniel
Pozefsky (argued), Residential Utility Consumer Office, Phoenix, Attorneys
for Residential Utility Consumer Office
Christina Estes-Werther, General Counsel, League of Arizona Cities and
Towns, Phoenix, Attorney for Amicus Curiae the League of Arizona Cities
and Towns
RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
John J. Egbert, Kenneth C. Sundlof, Jr., Jennings, Strouss & Salmon, P.L.C.,
Attorneys for Amicus Curiae Southwest Gas Corporation
Thomas A. Loquvam, Arizona Public Service Company, Phoenix; and
Matthew E. Price, William K. Dreher, Jenner & Block LLP, Washington,
D.C., Attorneys for Amicus Curiae Arizona Public Service Company
Thomas H. Campbell, Michael T. Hallam, Lewis Roca Rothgerber Christie
LLP, Phoenix, Attorneys for Amicus Curiae EPCOR Arizona, et al.
Timothy M. Hogan, Joy Herr-Cardillo, Arizona Center for Law in the Public
Interest, Phoenix, Attorneys for Amicus Curiae Arizona Center for Law in
the Public Interest
Michael W. Patten, Timothy J. Sabo, Snell & Wilmer L.L.P., Phoenix; and
Bradley S. Carroll, Tucson Electric Power Company, Tucson, Attorneys for
Amicus Curiae Tucson Electric Power Company, et al.
Court S. Rich, Loren R. Ungar, Evan Bolick, Rose Law Group, PC,
Scottsdale, Attorneys for Amicus Curiae Energy Freedom Coalition of
America
Timothy Berg, Theresa Dwyer-Federhar, Fennemore Craig, P.C., Phoenix,
Attorneys for Amicus Curiae Water Utilities Association of Arizona
Meghan H. Grabel, Osborn Maledon, Phoenix, Attorneys for Amicus
Curiae Arizona Investment Council
Jennifer A. Cranston, Gallagher & Kennedy, P.A., Phoenix, Attorneys for
Amicus Curiae Grand Canyon State Electric Cooperative Association Inc.
Timothy J. Sabo, Snell & Wilmer L.L.P., Phoenix, Attorney for Amicus
Curiae Global Water Resources, Inc.
Julie Nepveu, AARP Foundation Litigation, Washington, DC; and Veronika
Fabian, Choi & Fabian, PLC, Chandler, Attorneys for Amicus Curiae AARP
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
JUSTICE BRUTINEL authored the opinion of the Court, in which CHIEF
JUSTICE BALES, VICE CHIEF JUSTICE PELANDER, JUSTICE TIMMER,
and JUDGE STARING * joined.
JUSTICE BRUTINEL, opinion of the Court:
¶1 The Arizona Corporation Commission (“Commission”)
determines the rates that a public service corporation (a “utility”) may
charge. The Arizona Constitution requires the Commission to determine
the fair value of a utility’s in-state property when setting rates, which
historically has occurred in a full rate case. During a full rate case, the
Commission scrutinizes a utility’s financial picture and holds many
hearings—often extending more than a year. Here the Commission
approved a rate increase mechanism known as the system improvements
benefit (“SIB”), allowing it to adjust rates between full rate cases to help a
utility recoup the cost of newly-completed infrastructure projects. We hold
that the SIB mechanism complies with the Arizona Constitution’s mandate
that the Commission determine the fair value of a utility’s property when
setting rates.
I. BACKGROUND
A. Procedural history
¶2 Arizona Water Company (“AWC”) is a private, for-profit
monopoly utility company that provides water service to several towns and
rural communities. AWC is currently undertaking extensive capital
improvements to its aging pipeline infrastructure. In 2011, AWC filed a rate
case with the Commission for its eastern group water systems (“Eastern
Group Case”). The next year AWC filed a similar rate case for its northern
group water systems (“Northern Group Case”). In both cases AWC sought
a rate increase and proposed a step-increase mechanism that would allow
the Commission to adjust rates between full rate cases. AWC argued that
recouping the costs of its infrastructure improvements through the
traditional mechanism would require a near-continuous series of lengthy
*
Justice Clint Bolick recused himself from this case. Pursuant to article 6,
section 3, of the Arizona Constitution, the Honorable Christopher Staring,
Judge of the Arizona Court of Appeals, Division Two, was designated to sit
in this matter.
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
rate cases, raising costs and exposing consumers to “rate shock” from
sudden, dramatic rate increases.
¶3 Attempting to settle the rate cases, AWC proposed the SIB
mechanism, which allows AWC to petition for a rate increase between rate
cases as new AWC infrastructure projects become active. See infra ¶¶ 7–9.
Despite opposition from the Residential Utility Consumer Organization
(“RUCO”), the Commission approved, with some modifications, the SIB
mechanism.
¶4 RUCO appealed. The court of appeals consolidated the
Eastern Group and Northern Group cases and vacated the Commission’s
approval of the SIB mechanism. Residential Util. Consumer Office v. Ariz.
Corp. Comm'n, 238 Ariz. 8, 9–10 ¶ 1, 355 P.3d 610, 611–12 (App. 2015).
Concerned the Commission would not consider all elements of a general
rate case proceeding when analyzing an SIB surcharge petition, the court
concluded that the SIB (1) did not fall within previously recognized
exceptions to the fair value requirement, and (2) did not “provide[] the
functional equivalent of a fair value determination.” Id. at 17–18 ¶¶ 47, 50,
355 P.3d at 619–20. As a result, the court held that “the SIB mechanism does
not comply with the Arizona Constitution’s mandate that the Commission
determine a public service corporation’s fair value when setting rates[.]” Id.
at 10 ¶ 1, 355 P.3d at 612.
¶5 We granted review because the scope of the Corporation
Commission’s constitutional authority to adopt new ratemaking
mechanisms is an issue of statewide importance. We have jurisdiction
under article 6, section 5(3), of the Arizona Constitution and A.R.S. § 12-
120.24.
B. Ratemaking: full rate cases and the SIB mechanism
¶6 The Commission is constitutionally charged with setting “just
and reasonable rates.” Ariz. Const. art. 15, § 3. The Commission sets rates
by finding the “fair value” of a utility’s in-state property, Ariz. Const. art.
15, § 14, and then using that value as the “rate base” in the following rate-
of-return formula: (Rate Base x Rate of Return) + Expenses = Revenue
Requirement. US West Commc’ns, Inc. v. Ariz. Corp. Comm’n, 201 Ariz. 242,
245 ¶ 13, 34 P.3d 351, 354 (2001). The Commission determines rates using
a proceeding called a “rate case,” now codified as Arizona Administrative
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
Code (A.A.C.) R14-2-103 (“Rule 103”). Rule 103 or “full” rate case
proceedings are complex. They typically attract many intervenors, require
voluminous and detailed filings, and involve multiple, lengthy hearings. A
Rule 103 rate case for a utility like AWC often takes more than a year to
process.
¶7 The SIB mechanism allows the Commission to adjust rates in
between rate cases, subject to various requirements and conditions. Under
the SIB framework, AWC must file a full rate case at least once every five
years. Within the rate case, the Commission must evaluate and pre-
approve all SIB-eligible infrastructure replacement projects. During the
interim years, AWC may file for only one SIB surcharge per year. Before a
project may be incorporated in the SIB surcharge calculation, it must be
completed and actively serving customers.
¶8 When AWC requests an SIB surcharge, it must submit current
financial documents, including a balance sheet reflecting the value of its
property—both older infrastructure and newly-constructed SIB projects
that are in use. The tax multiplier, depreciation rate, and authorized rate of
return used in calculating the SIB must be the same as those approved by
the Commission in the most recent rate case. Before a surcharge may take
effect, the Commission must provide 30-days public notice and receive and
consider objections.
¶9 Every year the Commission must conduct a “true-up”
calculation to reconcile revenue collected through the SIB surcharge with
revenue authorized for the previous period. Any over-collection is re-
funded to customers. To compensate for efficiency-based savings resulting
from the improved infrastructure, AWC must issue a credit to customers in
the form of a refund equal to five percent of the SIB surcharge. Both the SIB
surcharge and efficiency credit must be clearly displayed on customers’
bills.
II. DISCUSSION
A. Standard of review
¶10 Whether the SIB mechanism complies with the Arizona
Constitution is a question of law we review de novo. See US West, 201 Ariz.
at 244 ¶ 7, 34 P.3d at 353. We generally presume the Commission’s actions
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
are constitutional, and we uphold them unless they are arbitrary or an
abuse of discretion. Ariz. Corp. Comm’n v. Ariz. Pub. Serv. Co., 113 Ariz. 368,
371, 555 P.2d 326, 329 (1976); Simms v. Round Valley Light & Power Co., 80
Ariz. 145, 154, 294 P.2d 378, 384 (1956).
B. The Arizona Constitution grants the Commission broad
discretion within its unique decision-making sphere
¶11 “The Arizona Corporation Commission, unlike such bodies in
most states, is not a creature of the legislature, but is a constitutional body
which owes its existence to provisions in the organic law of this state.”
Ethington v. Wright, 66 Ariz. 382, 389, 189 P.2d 209, 214 (1948); see Ariz.
Const. art. 15 (“The Corporation Commission”), §§ 1–19. As relevant here,
the powers and duties of the Commission are described in article 15, § 3:
The corporation commission shall have full power to, and
shall, prescribe just and reasonable classifications to be used
and just and reasonable rates and charges to be made and
collected, by public service corporations within the state for
service rendered therein, and make reasonable rules,
regulations, and orders, by which such corporations shall be
governed in the transaction of business within the state[.]
Regarding the Commission performing these duties, article 15, § 14,
provides:
The corporation commission shall, to aid it in the proper
discharge of its duties, ascertain the fair value of the property
within the state of every public service corporation doing
business therein; and every public service corporation doing
business within the state shall furnish to the commission all
evidence in its possession, and all assistance in its power,
requested by the commission in aid of the determination of
the value of the property within the State of such public
service corporation.
¶12 The Commission has full and exclusive power to set “just and
reasonable rates” for public service utilities. See Ariz. Const. art. 15, § 3; see
also State v. Tucson Gas, Electric Light & Power Co., 15 Ariz. 294, 306, 138 P.
781, 786 (1914). As we have previously observed:
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
[I]n the matter of prescribing classifications, rates, and
charges of public service corporations and in making rules,
regulations, and orders concerning such classifications, rates,
and charges by which public service corporations are to be
governed, the Corporation Commission has full and exclusive
power. In such field the Commission is supreme and such
exclusive field may not be invaded by the courts, the
legislature, or the executive.
Ethington, 66 Ariz. at 392, 189 P.2d at 216; see also Tucson Gas, 15 Ariz. at 301–
03, 138 P. at 784–85 (holding that because article 14, § 6, of the Arizona
Constitution authorizes the state legislature to enlarge the powers and
extend the duties of the Commission, the Constitution impliedly prohibits
the legislature from exercising powers assigned to the Commission); Ariz.
Pub. Serv. Co., 113 Ariz. at 371, 555 P.2d at 329 (“We would not presume to
instruct the Commission as to how it should exercise its legislative
functions.”).
C. The Commission must use current fair value as the basis for
setting rates for monopoly, for-profit utilities
¶13 The Commission generally must use its determination of fair
value as the basis for calculating a reasonable return on a utility’s
investment and, in turn, a proper rate. Ariz. Corp. Comm’n v. Ariz. Water
Co., 85 Ariz. 198, 202, 335 P.2d 412, 414 (1959); see supra ¶ 6. Although this
“traditional approach” is not constitutionally required in all cases, see US
West, 201 Ariz. at 246 ¶ 19, 34 P.3d at 355 (considering ratemaking for a
utility in a competitive industry and finding that “[i]n such a climate, there
is no reason to rigidly link the fair value determination to the establishment
of rates”), we have repeatedly required its use in ratemaking for private,
for-profit monopolies like AWC. Simms, 80 Ariz. at 151, 294 P.2d at 382; see
also US West, 201 Ariz. at 246 ¶ 19, 34 P.3d at 355 (“We still believe that when
a monopoly exists, the rate-of-return method is proper.”). Similarly, we
have held that, with some limited exceptions, fair value must be determined
when rates are set. Ariz. Water Co., 85 Ariz. at 201–02, 335 P.2d at 414–15;
Simms, 80 Ariz. at 151, 294 P.2d at 382. As a result, in order to fix just and
reasonable rates for AWC and other for-profit monopoly utilities, the
Commission is obligated to base rates on the current fair value of the
utility’s property.
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
D. The fair value requirement applies only to the “rate base”
variable of the traditional ratemaking formula
¶14 Under Arizona’s Constitution, the “fair value” requirement
applies only to the “rate base” element of the traditional ratemaking
equation. US West, 201 Ariz. at 245 ¶ 13, 34 P.3d at 354; see supra ¶ 6. The
rate base element involves a calculation of, in the Constitution’s language,
“the fair value of the [utility’s] property within the state.” Ariz. Const. art.
15, § 14. On the other hand, the rate of return, expenses, and revenue
requirement elements do not measure the value of the utility’s assets. In
Arizona Public Service Company, we explained, “Under the constitution as
interpreted by this court, the Commission is required to find the fair value
of the company’s property and use such finding as a rate base for the purpose
of determining what are just and reasonable rates.” 113 Ariz. at 370, 555
P.2d at 328 (citing Simms, 80 Ariz. 145, 294 P.2d 378) (emphasis added); see
also Scates v. Ariz. Corp. Comm’n, 118 Ariz. 531, 534, 578 P.2d 612, 615 (App.
1978) (“[T]he Commission must first determine the ‘fair value’ of a utility’s
property and use this value as the utility’s rate base.”). Accordingly, we
reject RUCO’s argument that “fair value” somehow encompasses the
determination of the appropriate rate of return.
E. The SIB contains a reasonable method for determining
AWC’s fair value rate base
¶15 The Commission is required to ascertain the fair value of the
company’s property and use that value as a rate base for calculating just
and reasonable rates. Simms, 80 Ariz. at 151, 294 P.2d at 382. But the
“constitution does not establish a formula for arriving at fair value” and we
have never prescribed one. Id.; Ariz. Water Co., 85 Ariz. at 202, 335 P.2d at
414. The method for determining fair value, then, falls within the
Commission’s discretion, and we will uphold a fair value determination
unless it “is arbitrary and unfair at the time it is made.” Ariz. Pub. Serv. Co.,
113 Ariz. at 371, 555 P.2d at 329. A full rate case is one permissible method
for determining fair value. Such a proceeding, however, is a product of the
Commission’s own rules and practice, see Rule 103. It is not constitutionally
mandated.
¶16 As the Commission explained in its decision, the SIB
mechanism is based on the fair value rate base of AWC’s property. The
mechanism uses the fair value determination made in the previous rate case
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
and adds the value of the infrastructure improvements once they are made.
AWC must submit up-to-date financial statements with each SIB surcharge
application, including an adjusted rate base schedule in which the value of
operational SIB projects is added to the underlying rate base from the
previous rate case. Using these financial statements, the Commission will
also update the fair value rate base and other elements of the formula from
the most recent rate case to “recognize changes in plant, accumulated
depreciation, contributions in aid of construction, advances in aid of
construction, and accumulated deferred income taxes . . . .” Ariz. Corp.
Comm’n, Decision No. 73938 at 51, W-01445A-11-0310, 2013 WL 5408684
(June 27, 2013). Although the Commission will not re-calculate anew every
input into the fair value determination, this updated measurement satisfies
the constitutional requirement that the Commission “ascertain the fair
value” of a public utility’s property “to aid it in the proper discharge of its
duties.” Ariz. Const. art. 15, § 14.
¶17 In finding that the Commission abused its discretion, the
court of appeals took a restrictive view of the requirement that the
Commission “ascertain the fair value” of a public utility “to aid” it in setting
rates. The court seemed to equate the full rate case procedure with the
constitutional requirement that the Commission determine the fair value of
a utility’s property, frequently using the terms “rate case” and “fair value
determination” interchangeably. See, e.g., Residential Util. Consumer Office,
238 Ariz. 8, 13 ¶ 27, 14 ¶ 33, 16 ¶ 40, 17 ¶¶ 45, 47, 18 ¶ 49, 355 P.3d 610, 615–
620. Because the fair value mechanism calculation within the SIB does not
require all the filings that would form part of a rate case, the court of
appeals concluded that the SIB was “inconsistent with the mandate that the
Commission perform a fair value determination ‘at the time of inquiry.’”
Id. at 17 ¶ 42, 355 P.3d at 619 (quoting Ariz. Corp. Comm’n, 85 Ariz. at 201–
02, 335 P.2d at 414–15).
¶18 In ruling that the SIB fails to properly assess current fair value
when setting rates, the court of appeals analyzed whether the SIB
mechanism could be upheld as an interim rate or an adjustor mechanism—
two ratemaking mechanisms that, under narrow circumstances set forth in
court of appeals cases, permit the Commission to approve rates without
making a current finding of fair value. See Residential Util. Consumer Office,
238 Ariz. at 12 ¶ 21, 355 P.3d at 614; Residential Util. Consumer Office v. Ariz.
Corp. Comm’n, 199 Ariz. 588, 591 ¶ 11, 20 P.3d 1169, 1172 (App. 2001); Scates,
118 Ariz. at 535, 578 P.2d at 616; see also Ariz. Corp. Comm’n v. Mountain
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RUCO V. AZ CORP COMMISSION/AZ WATER CO.
Opinion of the Court
States Tel. & Tel. Co., 71 Ariz. 404, 412–13, 228 P.2d 749, 754–55 (1951). The
court found that the SIB resembled neither pre-approved mechanism. We
agree that the SIB is neither an interim rate nor an adjustor mechanism, but
we disagree that this ends the inquiry. As we explained above, SIB rate
adjustments will be based on a current finding of the fair value of AWC’s
property. By supplementing and updating the fair value determination
from a previous rate case, the SIB satisfies the constitutional mandate that
the Commission determine fair value to aid it in setting rates.
¶19 In reaching its conclusion, the court of appeals relied heavily
on its opinion in Scates. That case, however, is inapposite. In Scates, the
court found that the Commission abused its discretion by imposing a rate
increase without considering any measure of fair value. 118 Ariz. at 534, 578
P.2d at 615. Such an increase, the court held, could not be justified as an
adjustor mechanism or interim rate. Id. at 535–36, 578 P.2d at 616–17. The
Scates court, however, did not assert that fair value can only be ascertained
through a full rate case; instead, it explicitly did not foreclose the possibility
that the Commission could satisfy the requirement by referring to
“previous submissions with some updating” or to “summary financial
information.” Id. at 537, 578 P.2d at 618. The SIB mechanism—grounded
in a current determination of fair value—comports with Scates, the Arizona
Constitution, and this Court’s cases.
III. CONCLUSION
¶20 As required by the Arizona Constitution, under the SIB
mechanism, the Corporation Commission will “ascertain the fair value” of
AWC’s property and use that determination “to aid” it in setting SIB
surcharge rates. As a result, we vacate the court of appeals’ opinion and
affirm the Commission’s orders approving the SIB mechanism.
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