in the supreme court of the state of arizona · in the supreme court of the state of arizona ......
TRANSCRIPT
IN THE SUPREME COURT OF THE STATE OF ARIZONA
RESIDENTIAL UTILITY CONSUMER OFFICE, an agency of the State of Arizona,
Appellant,
v.
ARIZONA CORPORATION COMMISSION,
Appellee,
ARIZONA WATER COMPANY,
Intervenor.
Arizona Supreme Court No. CV-15-0281-PR
Court of Appeals Division One
No. 1 CA-CC 13-0002 No. 1 CA-CC 14-0001
Arizona Corporation Commission No. W-01445A-11-0310 No. W-01445A-12-0348
BRIEF FOR AARP AS AMICUS CURIAE
SUPPORTING APPELLANT WITH CONSENT OF ALL PARTIES
Julie Nepveu*
*(Pro Hac Vice Pending)
AARP Foundation Litigation
601 E St., NW
Washington, DC 20049
Attorney for Amicus Curiae AARP
Veronika Fabian*, State Bar 018770
*Counsel of Record
CHOI & FABIAN, PLC
90 S. Kyrene Rd., Suite #5
Chandler, AZ 85226
Attorney for Amicus Curiae AARP
i
TABLE OF CONTENTS
STATEMENT OF INTEREST ................................................................................ 1
INTRODUCTION AND SUMMARY OF THE ARGUMENT ............................. 1
ARGUMENT ........................................................................................................... 3
I. Utility rates that are not just and reasonable endanger the
health, financial security, and wellbeing of older and
low-income ratepayers ................................................................................... 3
II. Setting just and reasonable utility rates as required by the
Arizona Constitution necessitates establishing all
elements of the rate making formula ............................................................. 7
A. Public utility rates are regulated pursuant to well-
established and fundamental principles that
balance the interests of the utility’s investors and
ratepayers ............................................................................................. 8
B. The surcharge approved by the Commission is a
type of “single issue surcharge” or “piecemeal
surcharge” that is inherently unfair to consumers ............................. 13
CONCLUSION ...................................................................................................... 17
ii
TABLE OF CITATIONS
CASES
Ariz. Corp. Comm’n v. Ariz. Pub. Serv. Co.,
113 Ariz. 368, 555 P.2d 326 (1976) ................................................................... 8
Ariz. Corp. Comm’n v. Ariz. Water Co.,
85 Ariz. 198, 335 P.2d 412 (1959) ................................................................... 16
Bluefield Water Works & Improvement Co. v. Pub. Serv. Comm'n,
262 U.S. 679 (1923) ..............................................................................11, 12, 13
Ethington v. Wright, 66 Ariz. 382, 189 P.2d 209 (1948) ......................................... 8
Fed. Power Commʼn v. Hope Nat. Gas Co., 320 U.S. 591 (1944) ................ 3, 9, 15
Fed. Power Comm’n v. Nat. Gas Pipeline Co., 315 U.S. 575 (1942) ............... 9, 15
L.A. Gas & Elec. Corp. v. RR Comm'n of Cal., 289 U.S. 287 (1933) ...9, 11, 12, 13
Memphis Light, Gas & Water Div. v. Craft, 436 U.S. 1 (1978) .............................. 4
Ruiz v. Hull, 191 Ariz. 441, 957 P.2d 984 (1998) ................................................... 8
Smith v. Illinois Bell Tel. Co., 282 U.S. 133 (1930) ....................................9, 11, 12
State v. Tucson Gas, 15 Ariz. 294, 138 P. 781 (1914) ............................................. 8
U.S. West Communs. v. Ariz. Corp. Comm’n,
201 Ariz. 242, 34 P.3d 351 (2001) ................................................................... 16
Verizon Communs., Inc. v. FCC, 535 U.S. 467 (2002) ...................... 10, 15, 16, 17
STATUTES, RULES AND REGULATIONS
Arizona Constitution
Art. XV, Sec. 3 .......................................................................................... 7, 8, 11
Art. XV, Sec. 14 ........................................................................................ 8, 9, 11
iii
Natural Gas Act of 1938
52 Stat. 821, 15 U. S. C. § 717 ........................................................................... 4
MISCELLANEOUS
AARP DataExplore, AARP Pub. Pol’y Inst.,
http://bit.ly/1TKrzeR (last visited Mar. 10, 2016) .............................................. 5
Extreme Weather and Public Health, Heat Safety-Heat related
Illness, Arizona Dep’t of Health Srvc’s,
http://1.usa.gov/1JfBS63 (last visited Mar. 8, 2016) .......................................... 7
Extreme Weather and Public Health, Older Adult Toolkit,
Arizona Dep’t of Health Srvc’s, http://1.usa.gov/1nvVLLX
(last visited Mar. 8, 2016) ................................................................................... 6
James C. Bonbright, PRINCIPLES OF PUBLIC UTILITY RATES,
Columbia Univ. Press (1961), reprinted by permission,
Powell Goldstein LLP (2005), http://bit.ly/1nzBftU .................................... 8, 10
Howat & Taormina, Home Energy Costs: The New Threat to
Independent Living for the Nation’s Low-Income Elderly,
Clearinghouse Rev. 552 (Jan. – Feb. 2008) ........................................................ 5
Increasing Use of Surcharges on Consumer Utility Bills, Larkin
& Associates, PLLC, for AARP (May 2012),
http://bit.ly/1p8eIpi .....................................................................................10, 14
Heat-Related Deaths After an Extreme Heat Event—Four
States, 2012, and United States, 1999–2009, Ctr’s for
Disease Control and Prevention, 62 Morbidity and Mortality
Weekly Report No. 22 (June 7, 2013),
http://1.usa.gov/1pcJkqi ...................................................................................... 6
Scott Hempling, REGULATING PUBLIC UTILITY PERFORMANCE:
THE LAW OF MARKET STRUCTURE, PRICING, AND
JURISDICTION 217, American Bar Association (2013),
http://bit.ly/1TxCBnd ........................................................................................ 11
iv
Heather C. McGhee & Tamara Draut, Retiring In The Red: The
Growth Of Debt Among Older Americans 2, Dēmos, (2004),
http://bit.ly/1XVvLHd ........................................................................................ 7
Public Utility Fortnightly, 2015 Rate Case Study (Nov. 2015),
http://bit.ly/1P1qoiI ........................................................................................... 12
Lynne Page Snyder & Christopher A. Baker, Affordable Home
Energy & Health: Making the Connections, AARP Pub.
Pol’y Inst. (2010), http://bit.ly/1UdzDDa ............................................... 1, 2, 4, 5
Michelle Singletary, Be attuned to seniors who carry a burden
of debt, The Washington Post (Feb. 9, 2016),
http://wapo.st/1RXMB7M .................................................................................. 7
Trends in Morbidity and Mortality from Exposure to Excessive
Natural Heat in Arizona, 2012, Arizona Dep’t of Health
Srvc’s (Feb. 7, 2014), http://1.usa.gov/1TO1yuW ............................................. 6
Neal Walters, Replacing the Nation’s Deteriorating Water
Infrastructure While Maintaining Affordable Water Rates,
AARP Pub. Pol’y Inst. Insight on the Issues 56 (Oct. 2011),
http://bit.ly/24QGxTX ........................................................................................ 4
Neal Walters, Utility Expenditures by Older Consumers, AARP
Pub. Pol’y Inst. (Mar. 2015), http://bit.ly/21YFO48 .......................................... 4
1
STATEMENT OF INTEREST
AARP is a nonprofit, nonpartisan organization with a membership dedicated
to protecting the needs and representing the interests of people aged fifty and older.
AARP is greatly concerned about the impact of high utility costs on older people
and regularly intervenes in utility rate-setting cases and files amicus curiae briefs
to protect the interests of older residential utility ratepayers. Excessive utility costs,
which comprise a substantial portion of one’s housing expense, can severely
burden older people, even if they own their home outright. Inability to pay utilities
can lead to eviction and foreclosure.
This appeal raises questions of significant importance to AARP: ensuring
that the Arizona Corporation Commission, in accordance with Arizona’s
Constitution, sets residential utility rates that are just and reasonable. AARP’s
participation in this case raises issues not discussed by the other parties and will
assist the Court in understanding the issues presented.
INTRODUCTION AND SUMMARY OF THE ARGUMENT
The facts in this case arise in the context of regulating a water utility, but
this Court’s decision will apply broadly to all utilities that are regulated by the
Arizona Corporation Commission (Commission). It will therefore have a broad
impact on older people, many of whom struggle to pay rising utility bills. See
Lynne Page Snyder & Christopher A. Baker, Affordable Home Energy & Health:
2
Making the Connections AARP Pub. Pol’y Inst. 2 (2010) [hereinafter Affordable
Home Energy and Health], http://bit.ly/1UdzDDa (“High and volatile home energy
costs make heating and cooling increasingly unaffordable to millions of low- and
moderate-income households, many of which include older persons.”). Because
income typically declines sharply as people advance to older ages, the cost of
essential utilities such as water and electricity for cooling often consumes
substantial portions of their monthly budgets. Unaffordable utility bills can cause
substantial deprivation and threaten older people’s health. Id. at 18-19.
Consistent with well-settled principles of public utility ratemaking and
longstanding Arizona precedent, the Court of Appeals held that the Arizona
Corporation Commission (Commission) violated Arizona’s Constitution when it
approved a surcharge on ratepayers’ bills to allow the Arizona Water Company—
without a rate proceeding, as required—to recover capital expenditures to replace
the system’s aging infrastructure, and charge a return on equity for those inflated
expenditures. This Court should affirm that holding.
The approved surcharge is a type of “single issue” or “piecemeal”
ratemaking that is inherently unfair to ratepayers. Single issue ratemaking produces
utility rates that are not just and reasonable because it overly compensates a utility
and violates numerous fundamental public utility ratemaking principles. For
example, it fails to encourage efficient management to keep rates low, does not
3
offset costs with the savings gained through efficiencies resulting from the
upgrades, and in this case, is calculated using a rate of return on equity that is well
in excess of the current market rate needed to attract capital.
The importance of this case is patent. This Court’s decision either will affirm
the fundamental ratemaking principles that have applied to the regulation of public
utilities to produce just and reasonable utility rates for over a century or it will
open the floodgates to ad hoc ratemaking. Arizona’s Constitutional requirement for
the Commission to set just and reasonable utility rates should not be cheapened.
The balanced, searching ratemaking process protects the public’s interest in just
and reasonable utility rates that cannot be assured through half measures or
shortcuts. AARP respectfully urges this Court to affirm the ruling of the Court of
Appeals, which upholds and reaffirms the fundamental and longstanding principles
governing regulated utility ratemaking.
ARGUMENT
I. Utility rates that are not just and reasonable endanger the health,
financial security, and wellbeing of older and low-income ratepayers.
Public utility regulators are charged with the obligation to ensure that utility
rates are “just and reasonable” to both investor-owned utilities and its captive
ratepayers. See Fed. Power Commʼn v. Hope Nat. Gas Co., 320 U.S. 591, 603
(1944) (reiterating that setting “‘just and reasonable’ rates involves a balancing of
the investor and the consumer interests.”) (quoting and construing the commonly-
4
applied ratemaking standard adopted in the Natural Gas Act of 1938, 52 Stat. 821,
15 U. S. C. § 717). “The customer’s interest is self-evident. Utility service is a
necessity of modern life; indeed, the discontinuance of water or heating for even
short periods of time may threaten health and safety.” Memphis Light, Gas &
Water Div. v. Craft, 436 U.S. 1, 18 (1978) (further noting at 14 n.15 that “the
uninterrupted continuity of [electric service] is essential to health and safety.”).
Utility costs typically consume a disproportionate percentage of an older
person’s monthly budget. For example, the typical low-income household, despite
using less energy on average than higher income households, spends 16 percent of
its annual income on home energy costs, and these costs are rising. See Affordable
Home Energy & Health, supra at 14; see also Neal Walters, Utility Expenditures
by Older Consumers, AARP Pub. Pol’y Inst. 1 (Mar. 2015), http://bit.ly/21YFO48
(reporting data from Bureau of Labor Statistics 2013 Consumer Expenditure
Survey shows percentage of expenditures on utilities increase with age and are
highest for people older than age 50). Rising utility costs, especially for water, are
a growing threat to older people’s financial security and health because “water
rates are increasing at a much faster pace than inflation or other utility rates. This
is a particular hardship for those with low incomes or on fixed incomes as the
percentage of their income needed to pay their water bill increases.” Neal Walters,
Replacing the Nation’s Deteriorating Water Infrastructure While Maintaining
5
Affordable Water Rates, AARP Pub. Pol’y Inst. Insight on the Issues 56 at 1 (Oct.
2011), http://bit.ly/24QGxTX.
Many older people have low incomes that make it very difficult for them to
manage rising utility costs. In Arizona, half of all people older than age 65 have
income below $21,200, and 10.7 percent have incomes below the federal poverty
level. AARP DataExplore, AARP Pub. Pol’y Inst., http://bit.ly/1TKrzeR (last
visited Mar. 10, 2016). When utilities are unaffordable, older and low-income
consumers are forced to make drastic decisions—such as whether to cool or eat, go
without lights or medication—that endanger their health and wellbeing. See
Affordable Home Energy and Health, supra, at 2 (finding “74 percent of
households that include older adults report that they cut back on the purchase of
household necessities because of high home energy bills.”). High utility costs also
threaten their ability to continue to live independently, forcing some into nursing
homes prematurely or causing homelessness. See Howat & Taormina, Home
Energy Costs: The New Threat to Independent Living for the Nation’s Low-Income
Elderly, Clearinghouse Rev. 552, 552-60 (Jan.–Feb. 2008). Lower income and
older people who cannot afford their utility costs may reduce their heating and
cooling to unsafe levels, increasing their risk of ill-health and even death. See
Affordable Home Energy and Health, supra at 2, 14.
6
Advancing age, particularly being age 65 and older, makes one “particularly
vulnerable to heat illness.” Extreme Weather and Public Health, Older Adult
Toolkit, Arizona Dep’t of Health Srvc’s, http://1.usa.gov/1nvVLLX (last visited
Mar. 8, 2016).
Age is a risk factor because older adults do not adjust as well to
changes in temperature compared to when they were younger. They
are also most likely to have a chronic medical condition that alters the
body's normal response to heat. Prescription medicine use is also
common in older adults. Some prescription medicines can impair the
body’s ability to regulate its temperature or can inhibit perspiration.
Id. Each year, over 600 Americans die from exposure to extreme heat, most often
inside of permanent homes with little or no air conditioning; a consistently high
percentage of them are older than age 65. See Heat-Related Deaths After an
Extreme Heat Event—Four States, 2012, and United States, 1999–2009, Ctr’s for
Disease Control and Prevention, 62 Morbidity and Mortality Weekly Report No.
22, 433 (June 7, 2013), http://1.usa.gov/1pcJkqi. “Between 2000 and 2012, 1,535
deaths from exposure to excessive natural heat occurred in Arizona.” Trends in
Morbidity and Mortality from Exposure to Excessive Natural Heat in Arizona
2012, Arizona Dep’t of Health Srvc’s 3, 7 (Feb. 7, 2014),
http://1.usa.gov/1TO1yuW (reporting “adults 65 years or older had the highest risk
of heatstroke or sunstroke among the age groups of Arizona residents,” 32.9
percent of deaths were people aged 65 or older, and “66.5 percent of at home
deaths were among decedents 65 years or older”). In addition, “1,572 emergency
7
department [ ] visits” were related to “exposure to excessive natural heat[.]” Id. at
21. Importantly, Arizona’s first rule for staying healthy in high heat is to drink
plenty of water. Extreme Weather and Public Health, Heat Safety-Heat related
Illness, Arizona Dep’t of Health Srvc’s, http://1.usa.gov/1JfBS63 (last visited Mar.
8, 2016).
The tradeoffs residential ratepayers are forced to make when utility expenses
are unaffordable also extend to more mundane but equally important choices for
financial security and overall wellbeing. Excess utility rates force ratepayers to
spend money they could otherwise save for a rainy day or to pay off debt.1 These
are significant concerns for older people who may not have enough money to
sustain them through their retirement years.
II. Setting just and reasonable utility rates as required by the Arizona
Constitution necessitates establishing all elements of the rate making
formula.
Arizona’s Constitution requires the Commission to “prescribe . . . just and
reasonable charges” for all regulated utilities. Art. XV, Sec. 3. The Arizona Court
1 Increasingly, older people are saddled with unaffordable debt loads, lagging
income, and rising costs for medical care, housing, and other necessities, including
utilities. Heather C. McGhee & Tamara Draut, Retiring In The Red: The Growth
Of Debt Among Older Americans 2, Dēmos, (2004), http://bit.ly/1XVvLHd.
Nearing their retirement years, older people “can’t rely on raises or job-hopping for
better pay to help dig them out.” Michelle Singletary, Be attuned to seniors who
carry a burden of debt, The Washington Post (Feb. 9, 2016),
http://wapo.st/1RXMB7M.
8
of Appeals aptly explained at ¶15-20 that Art. XV, Sec. 14 of Arizona’s
Constitution provides that “to aid in the proper discharge of its duties,” the
Commission is obliged to “ascertain the fair value of property.” Opinion at ¶19.
The Commission must “use such findings as a rate base for the purpose of
determining what are just and reasonable rates.” Id. (quoting Ariz. Corp. Comm’n
v. Ariz. Pub. Serv. Co., 113 Ariz. 368, 370, 555 P.2d 326, 328 (1976)).2 The Court
of Appeals’ decision should be affirmed because it upholds and reaffirms this
Court’s interpretation of Arizona’s Constitution and is consistent with fundamental
principles governing the regulation of public utilities for over a century.
A. Public utility rates are regulated pursuant to well-established and
fundamental principles that balance the interests of the utility’s
investors and ratepayers.
Public utilities generally operate as regulated monopolies; the monopoly
structure provides the most economically efficient means to attract the large capital
investment needed to build, operate, and maintain the infrastructure necessary to
provide essential utility services. See James C. Bonbright, PRINCIPLES OF PUBLIC
UTILITY RATES 10, Columbia Univ. Press (1961), reprinted by permission, Powell
Goldstein LLP (2005), http://bit.ly/1nzBftU. In exchange for operating as a
2 This Court consistently has recognized that the Court must construe the state
Constitution as a whole, reading its sections together. See Ruiz v. Hull, 191 Ariz.
441, 448 ¶ 24, 957 P.2d 984, 991 (1998); Ethington v. Wright, 66 Ariz. 382, 392,
189 P.2d 209, 216 (1948); State v. Tucson Gas, 15 Ariz. 294, 303, 138 P. 781, 785
(1914). Thus, the link between Section 3 and Section 14 of Art. XV is clear.
9
monopoly, the law imposed on public utilities a duty to serve all captive ratepayers
in their service area on a non-discriminatory basis, at rates that are “just and
reasonable.” Id. For over a century, public utility regulators have been obligated to
set rates that protect the public’s interest. See Hope Nat. Gas, 320 U.S. at 603.
Regulated public utilities (and their investors) are not entitled to a dollar-for-
dollar return of their expenses. See id. (requiring costs to be offset by
depreciation). Nor are investors guaranteed a return on their equity investment. See
Fed. Power Comm’n v. Nat. Gas Pipeline Co., 315 U.S. 575, 590 (1942)
(reiterating that “regulation does not insure that the business shall produce net
revenues.”). Rather, they are entitled only to a “fair value” for providing essential
utility service. Art. XV, Sec. 14; See Smith v. Illinois Bell Tel. Co., 282 U.S. 133,
161 (1930). See L.A. Gas & Elec. Corp. v. RR Comm'n of Cal., 289 U.S. 287, 305
(1933) (noting “[t]his Court has repeatedly held that the basis of calculation is the
fair value of the property, that is, that what the complainant is entitled to demand,
in order that it may have ‘just compensation,’ is ‘a fair return upon the reasonable
value of the property at the time it is being used for the public.’”) (citing cases
dating from 1898). To be effective at protecting the interests of ratepayers, utility
regulation must provide a financial incentive for utilities to keep expenses low and
manage the utility efficiently. Thus, ratepayers are not required to pay imprudently
incurred expenses that reward poor management decisions or fail to keep expenses
10
low.3 See id.; Bonbright, supra, at 173.
4 See Verizon Communs., Inc. v. FCC, 535
U.S. 467, 485 (2002) (explaining “the cost of prudently invested capital used to
provide the service” is calculated “subject to deductions for accrued depreciation
and allowances for working capital . . . naturally leading utilities to minimize
depreciation by using very slow depreciation rates (on the assumption of long
useful lives), and to maximize working capital claimed as a distinct rate-base
constituent”). Additionally, to be fair to the ratepayers as well as the investors,
recoverable expenses for infrastructure improvements and operations must be
offset by any cost savings realized by the utility, such as from efficiencies gained
as a result of new technologies or infrastructure improvements.5 Id.
3 See Increasing Use of Surcharges on Consumer Utility Bills, Larkin & Assoc.,
PLLC, for AARP 9 (May 2012), http://bit.ly/1p8eIpi (“Guaranteeing recovery of a
specific expense reduces the utility’s incentives to control costs, and thus shifts the
burden of cost increases between rate cases from shareholders onto ratepayers.”).
4 See id. (“In a rate case a utility is allowed a reasonable level of revenues to
recover its operating expenses as well as an opportunity to earn a fair return on its
prudently incurred investment in used and useful plant. In between rate cases, the
benefit of any cost reductions would flow back to the utility as higher profits.”).
5 See id. (“A key concept in accounting and ratemaking is the matching principle.
The matching principle involves matching revenues with related expenses and
investments in the time period they occur. Accounting and ratemaking require the
cost of capital investments to be spread over the period in which they will be used.
Capital investments, such as replacement of equipment at the utility’s plant can
produce efficiencies such as reducing future [operating and maintenance] costs or
enable new revenues. If the cost of the capital expenditure is recovered through a
surcharge, these efficiencies may not be captured in the surcharge. Recovering
11
Consistent with traditional public utility ratemaking principles, the phrase
“fair value” in the Arizona Constitution represents more than strictly the “rate
base” element of the ratemaking formula;6 it also includes a rate of return
established based on the prevailing market conditions at the time of the
ratemaking. See L.A. Gas & Elec. Corp, 289 U.S. at 319 (reiterating requirement
that rate of return be evaluated at the time of the ratemaking because “a rate of
return may be reasonable at one time and become too high or too low by changes
affecting opportunities for investment, the money market and business conditions
generally.”) (quoting Bluefield Water Works & Improvement Co. v. Pub. Serv.
Comm'n, 262 U.S. 679, 693 (1923)).
It is essential for regulators to consider each of the components of this
formula contemporaneously in order to set “just and reasonable” rates and charges.
Arizona Constitution, Art. XV, Secs. 3 and 14; see Smith, 282 U.S. at 161. It is
improper to take “rate base” out of context of a rate making proceeding to allow a
capital investments via a surcharge can thus violate the matching principal. . . .
There is also the risk that overpayment of costs may be not be returned to
customers, because if the surcharge costs are reviewed only on a cursory basis, any
errors or overcharges may not be detected and/or returned to customers.”).
6 The rate making formula for utility regulation is generally stated as: Revenue
Requirement = (Rate Base * Rate of Return) + Operating Expenses. See Scott
Hempling, REGULATING PUBLIC UTILITY PERFORMANCE: THE LAW OF MARKET
STRUCTURE, PRICING, AND JURISDICTION 217, American Bar Association (2013),
http://bit.ly/1TxCBnd.
12
utility to recover all expenses as they are incurred or to allow a higher rate of
return than needed to attract capital in the prevailing and relevant economic
market. See id. A return on equity that is not calculated based current market
conditions may overly compensate the utility’s investors at the expense of
ratepayers. See id.; L.A. Gas & Elec. Corp, 289 U.S. at 319.
In violation of this fundamental principle, which protects both investors and
consumers, the Commission approved rates based on an outdated rate of return.
Using a 10.55 percent rate of return on common equity approved in the previous
water company rate case applies a stale and arguably excessive return to current
rate base, resulting in water rates that are higher than necessary, and are thus unjust
and unreasonable to ratepayers.7 See Smith 320 U.S. at 161; Bluefield, 262 U.S. at
693. It is improper for the Commission simply to assume that a return found at one
time to be fair remains so in the current market conditions or that it will continue to
remain fair into the indefinite future during which the System Improvement
Benefit (SIB) is intended to operate. L.A. Gas & Elec. Corp, 289 U.S. at 319.
7 Public utility commissions around the country since 2014 overwhelmingly have
been allowing rates of return on common equity (ROE) that are lower than they
were in previous ratemakings and are typically far below the 10.55 percent allowed
by the Commission. See Public Utility Fortnightly, 2015 Rate Case Study 17-21
(Nov. 2015), http://bit.ly/1P1qoiI. These lower ROE reflect the improved
economic conditions for utilities to attract investors around the country since the
end of the Great Recession.
13
Moreover, allowing cost recovery through the SIB does not satisfy the
fundamental ratemaking requirement to determine “[w]hat annual rate will
constitute just compensation[, which] depends upon many circumstances and must
be determined by the exercise of a fair and enlightened judgment, having regard to
all relevant facts.” Bluefield, 262 U.S. at 692. In approving a 10.55 percent return
on common equity, the Commission impermissibly failed to consider the impact of
the changed economic conditions and rate structure since the previous rate
proceeding. See L.A. Gas & Elec. Corp, 289 U.S. at 319. The authorized ROE
should be based upon current market conditions impacting capital costs and reflect
the likely substantial reduction in the utility’s risk profile.
B. The surcharge approved by the Commission is a type of “single
issue surcharge” or “piecemeal surcharge” that is inherently
unfair to consumers.
The SIB surcharge approved by the Commission allows water utility rates to
increase without a contemporaneous examination and determination of all elements
of the ratemaking formula. This piecemeal approach does not comply with
Arizona’s Constitutional requirement and violates traditional principles governing
utility ratemaking that “all relevant factors” should be considered
contemporaneously when rates are set.
AARP has long opposed “single-issue rate making” because it is inherently
unfair to residential ratepayers. “Utilities are generally required to ‘net’ all costs
14
and benefits of operation at the time rates are set to avoid ‘cherry-picking’
individual cost increases that may be offset by other cost decreases.” See
Increasing Use of Surcharges on Consumer Utility Bills, supra at 1. Specifically,
Single issue ratemaking involves “singling out” specific
expenditures from a company’s base rates and allowing a utility to
separately recover those costs from ratepayers. Singling out
specific costs can make the traditional ratemaking formula
unbalanced. For example, if a utility replaces a large piece of
equipment at its plant, the new equipment will affect multiple
aspects of the business. The utility’s rate base plant will increase,
and revenues may increase, if the plant addition is to serve new
customers. Future maintenance expenses may decrease if the
addition improves efficiency. The lower maintenance costs, which
would reduce rates for ratepayers, may not be reflected within a
surcharge that focuses only on the new investment.
Id. at 2. Moreover, single issue ratemaking typically involves only a limited
review of factors necessary to ensure that rates are fair. Id. at 9-10 (explaining that
with single issue ratemaking, “[u]tilities typically submit reports to regulators for
costs recovered via a surcharge on an annual or quarterly basis. This usually
involves submitting some calculations and workpapers identifying and supporting
the amounts. The review by regulators is typically conducted on an expedited
basis, as opposed to the thorough review that would typically occur in a full rate
case. In rate case, a thorough review of costs can also be conducted by intervening
parties, and the utility must adequately support its costs or they risk being
disallowed.”).
15
In this case, the SIB indefinitely entitles the utility to recover virtually all of
its capital expenditures, without reduction from a thorough prudence review,
matching cost savings, or reduction for depreciation that normally would be
considered—in an adversarial proceeding involving all interested parties—during a
rate case. Intervenor and Amici water companies have argued in this appeal that
“fair value” of certain property (rate base) can be determined in isolation of the
remaining rate making components (i.e., rate of return, operating expenses). But
this mismatch means that consumers may be paying higher water rates, even if the
overall cost of providing water service is lower, due to offsetting reduction in the
rate of return that is necessary or due to contemporaneous reductions in the water
company’s reasonable expenses. See Hope Nat. Gas, 320 U.S. at 603. In addition,
the SIB allows a return on equity based on the improperly inflated value of such
capital expenditures.
In approving the SIB, the Commission also fails to account for other relevant
factors, such as the possibility of inefficient management of the utility or wasteful
spending.8 See Nat. Gas Pipeline, 315 U.S. at 597 (recognizing that “[t]he
8 See Verizon, 535 U.S. at 499 (reviewing historical development of “fair value” in
public utility regulation and explaining “‘[c]ost’ as used in calculating the rate base
under the traditional cost-of-service method did not stand for all past capital
expenditures, but at most for those that were prudent, while prudent investment
itself could be denied recovery when unexpected events rendered investment
useless . . . . And even when investment was wholly includable in the rate base,
16
regulated business here seems exceptionally free from hazards which might
otherwise call for special consideration in determining the fair rate of return.”).
The Commission argues that the traditional ratemaking formula is too rigid,
despite the fact that this Court has continuously recognized and upheld the formula
as the constitutionally proper method for setting rates for monopoly utilities. See
U.S. West Communs v. Ariz. Corp. Comm’n, 201 Ariz. 242, 246, 34 P.3d 351, 355
(2001). But the Commission’s obligation to consider all of the relevant factors
when determining “fair value”, which includes all of the elements of the rate
making formula at the time that it sets rates (and thus avoiding piecemeal
ratemaking) is clear. The Commission is required to exercise “reasonable judgment
concerning all relevant factors when determining the fair value of [utility]
properties at the time of inquiry.” Ariz. Corp. Comm’n v. Ariz. Water Co., 85 Ariz.
198, 201, 335 P.2d 412, 414 (1959). A rate case is the best opportunity ratepayers
have to “match the capacity of utilities having all the relevant information to
manipulate the rate base[.]” Verizon, 535 U.S. at 486. It is essential to protect and
uphold the ratemaking process that the Commission derides because it serves as
the “ratepayer[s] . . . important protection [to] mitigate[e] the tendency of a
rate makers often rejected the utilities’ ‘embedded costs,’ their own book-value
estimates, which typically were geared to maximize the rate base with high
statements of past expenditures and working capital, combined with unduly low
rates of depreciation.”) (citing Hope Nat. Gas, 320 U.S. at 587-98).
17
regulated market’s lack of competition to support monopolistic prices.” Id. The
SIB approved by the Commission was properly rejected by the Court of Appeals.
This Court should affirm the decision of the Court of Appeals because consumers
deserve to have their utility rates fairly set. In fact, Arizona’s Constitution requires
it.
CONCLUSION
Respectfully, AARP urges this Court to affirm the decision of the Court of
Appeals that upholds Arizona’s Constitutional requirement for the Commission to
establish “just and reasonable” charges for all regulated utilities.
RESPECTFULLY SUBMITTED this 10th day of March, 2016.
/s/Veronika Fabian*
*Counsel of Record
CHOI & FABIAN, PLC
90 S. Kyrene Rd., Suite #5
Chandler, AZ 85226
Attorney for Amicus Curiae AARP