A public utility is entitled to such rates as will 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 realized or anticipated in highly profitable enterprises or speculative ventures.
The return should be reasonable sufficient to assure confidence in the financial soundness of the utility, should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise money necessary for the proper discharge of its public duties. 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. -- U.S. Supreme Court in Bluefield Water Works and Improvement Co. v. Public Service Commission of W. Virginia, 1923.
In a chilly 13th floor hearing room in a state office building here, the Virginia Electric and Power Co. is trying to convince the State Corporation Commission that it ought to be granted a $231.4 million rate increase that would be the largest in its history.
For all the high stakes, both for the company and its customers, there is little sense of drama as the often arcane testimony drones on. Most of the lawyers for the company, the SCC, the state attorney general's office and the handful of private protesters have played these same roles before, and they seem to know their lines by heart. The three members of the SCC, sitting as a court, listen patiently, occasionally interjecting queries of their own.
Former Lt. Gov. Henry E. Howell Jr., a liberal Democrat who partly built his career with flamboyant opposition to Vepco rate requests, no longer is putting in appearances. In fact, only a few members of the public asked to speak and even fewer showed up to do so.
The scene before the commission is one that regularly is played out all across the nation as federal, state and local regulators cope with the flood of requests for higher rates from hard-pressed utilities. Some of the issues in these cases, including the Vepco proceeding, have been the standard fare of regulation for many decades:
How high should a utility's rate return be?
How large is its rate base -- the utility's investments in plants and equipment dedicated to provide service to its customers?
Are rate schedules structured so that each class of customer pays a fair share of the cost of service?
Historically, one could multiply the chosen rate of return by the value of the rate base, double the result to offset a 50 percent federal income tax and come up with a figure for the revenue a utility needed. Then the regulator could set a "fair" rate structure to provide that level of revenue.
While there were no guarantees, electric utilities generally were stable, safe investments that paid a lower return than unregulated companies precisely because they were less risky.
But the calm world of utilities has long since been shattered by the energy crisis, the furor over safe use of nuclear power and the depressing impact of slow-moving regulators in a fast-moving world. These changes have left many of the nation's electric utilities financially battered, and Vepco is no exception.
Last year Vepco, the 10th-largest electric utility in the country, earned $241.6 million, or $1.93 per share, on revenues of $2.1 billion.It was a better performance than in any of the previous four years, but the company was still in financial trouble.
Once again Vepco missed earning the 13.5 percent after-tax rate of return on stockholder equity the SCC granted it in 1975; in fact, it has never achieved that return. The cost of paying interest on Vepco's outstanding debt is so large relative to its earnings that, under the conditions of its charter, it could not this year sell any more preferred stock. And finally, for the seventh year in a row, it was forced to sell additional shares of common stock at a price well below the per-share value of the assets on the company books, diluting the value of previously issued shares.
In this new and uncertain world for utilities, the traditional questions of regulation are not the only ones that have to be answered. To them have to be added these:
Should customers have to pay a return on capital invested in new facilities while they are still under construction or only when they are completed, and therefore "used and useful," as regulators put it, in terms of providing service to customers?
Should the customers or the stockholders pay for an expensive bad guess by management on whether a new generating plant will be needed?
Should customers be paying now for the eventual but still unknown cost of disposing of spent nuclear fuel?
As in any court proceeding -- and this is one, with rules of evidence, objections, cross-examination of witnesses, and after a decision, the right of direct appeal to the Virginia Supreme Court -- predicting an outcome is hazardous. However, even the principal witnesses for the opposition concede that the answers to all these questions in Vepco's case indicate the need for a significant rate increase.
The essential problems faced by Vepco and other major utilities are soaring costs and greatly increased uncertainty about the future demand for energy. As fast as electricity costs have gone up in the past decade, the cost of the things a utility buys -- primarily fuel and new generating plants -- has gone up even faster. With the inevitable regulatory lag between asking for higher rates and getting them, the utilities have been squeezed. Their financial position has generally deteriorated at the same time their need to borrow at far higher interest rates to finance the escalting costs of new plants and pollution-control equipment has grown.
Meanwhile, a new difficulty has emerged, ironically providing part of the solution to the financing problem. Projections of future demand for electricity have plummeted -- in Vepco's case from an estimate of more than 10 percent growth annually to only 2.1 percent growth in the peak summer load and 2.8 percent in the winter peak -- leaving in their wake a long list of canceled generating-plant projects. While that means lower capital needs, many projects are being dropped after millions of dollars have been spent on them, and the regulators have to decide who pays, investors or customers?
Vepco first canceled two nuclear units, Surry 3 and 4, in 1977. The State Corporation Commission has allowed the company to write off a $74.5 million loss over 10 years, but not to add that cost to the Vepco rate base. That way, the stockholders are getting their money back but earning no return in the meantime.
Last year using what Vepco President William W. Berry calls "dramatically upgraded, more sophisticated" demand-forecasting techniques, it decided to cancel another nuclear unit, North Anna 4, and to sell a portion of a $1.6 billion pumped storage project in Bath County to another utility. This time Vepco not only wants to write off $122 million for North Anna 4 over 10 years, but also to add that figure to the rate base.
The decision to build North Anna 4 was "reasonable when it was made," Berry maintains. He says this judgment has been the "traditional test. Not 'was the decision perfect,' but 'was it reasonable?'" If it was, then the costs ought to be in the rate base, just like any other investment, he argues. Some of Vepco's opponents in the proceeding, such as the Virginia Consumer Congress, say no dice. It was a Vepco mistake and Vepco stockholders should pay. Other opponents want the SCC again to allow recovery but not a return.
In the other major nuclear issue in the case, Vepco wants $20.9 million as a first-year installment on paying the eventual cost of disposing of the rapidly mounting pile of spend nuclear fuel. However, no one knows what that cost ultimately will be.
Since one of the tenets of utility regulation is that revenue requirements should be based on known costs, not uncertain estimates, Vepco is seeking to break new ground with this request. On the other hand, Vepco is basing its argument on yet another standard element of regulation, namely, that today's customers should pay the full cost of today's service. The nuclear fuel is being partially consumed in generating electricity now, and the cost of disposal is directly related to providing service now.
But Vepco promptly switches gears in arguing for another portion of its requested rate increase. Even with the sale of part of the Bath County project and the North Anna 4 cancellation, it still needs about $4 billion to pay for new construction and more than $600 million to refinance maturing debt issues from now through 1985. To cut its financing burden, Vepco wants to include in its rate base the costs of future construction as they occur instead of when a project is complete.
This approach, known as construction-work-in-progress (CWIP), means essentially that the financing costs during construction are borne by present customers rather than the company. At present, Vepco adds those financing costs to the value of the plant when it is complete. That means that the plant's cost is higher, and that property taxes are higher, too.
Vepco Controller B. D. Johnson testified that the remaining nuclear unit under construction. North Anna 3, will cost an estimated $2.1 billion under present procedures. If CWIP were allowed, it would cut that by $360 million. And over the life of the plant, customers would need to provide $3.2 billion less in revenues to cover its cost.
However, CWIP also means that customers would be paying higher rates now than they otherwise would be. Should today's customers have to pay more so that future customers can pay less? The SCC's answer could turn on just how serious it decides Vepco's financial plight is. The Federal Energy Regulatory Commission, which sets wholesale electricity rates, approves CWIP only when a utility can raise necessary funds in no other reasonable way.
Most of Vepco's residential and business customers probably are not aware of how much hot water the utilities are in. Individuals just know rates have soared. The cost of electricity included in the consumer price index, for instance, has gone up 162.6 percent in the last 10 years.
Last year Vepco got three separate rate hikes. The first, for $18.1 million, came on April 1 because the company's rate of return on equity in 1978 was well below the authorized 13.5 percent. The second, $60 million effective Oct. 1, covered a 1979 shortfall. Finally, in mid-December, Vepco added another $46 million to its rates when the North Anna Unit 2 nuclear plant began full commercial operation.
But during the course of 1980, Vepco was able to boost operation of its nuclear plants and able to buy large quantities of power produced by other utilities using coal. This enabled Vepco to cut operation of its high-cost, oil-fired plants, with the saving on fuel costs more than offsetting the $124 million worth of rate increases.
Most utility customers are also unaware of the enormous impact federal income taxes have on the rates they pay. Since Vepco, at least in theory, must pay a 46 percent federal income tax on most of its earnings, its customers must pay an additional $1.85 for Vepco to have another $1 in after-tax earnings. In other words, Vepco's rate increase request would have been only a bit more than half as large except for this tax effect.
On the other hand, because of the use of accelerated depreciation, the investment tax credit and some other provisions of the tax code. Vepco does not end up actually paying such high taxes. The difference between what the company hands over to the Internal Revenue Service and what its financial reports say is its tax liability goes into a "deferred tax account." Last year Vepco added $52.2 million to its cost-free capital in this fashion. Nationwide, deferred taxes provide a significant share of all capital available to utilities.
As the leadoff witness for the company before the SCC, Vepco President Berry said the $189 million rate hike is an essential part of the effort to get the company back on a sound financial footing. In particular, Berry said the rate increases would help get Vepco stock back up to book value. "If the company were earning the true cost of equity capital, its shares would be selling at or slightly above book value," he testified. "Its persistent failure to do this is a sign of poor economic health and a circumstance that is harmful to the company's customers as well as its shareholders.
"Of course, a major part of the problem is that the company, like other utilities, has been unable, principally because of inflation and regulatory lag, to earn the return on common equity that the commission has found to be reasonable, but this problem is multiplied when the allowed return is, as at present, substantially below the cost of capital," Berry said.
To remedy that, Vepco has asked that the SCC raise its allowed 13.5 percent rate of return to 16.5 percent. That change, according to the company, accounts for about $75 million worth of the requested higher rates. It is also the guts of the traditional regulatory question the SCC must decide.
Estimates of the cost of capital are about as numerous as there are witnesses in proceedings such as this. In opening statements, various parties to the case all said lower rates of return would be adequate to ensure that the company still is able to sell stock or issue bonds to raise money. But they all suggested that some increase in the rate of return is in order, with most indicating a preference in the 14 percent to 15 percent range.
Sen. Clive L. DuVal II (D-Arlington), who often intervenes in these cases on behalf of his constituents, says estimating a proper rate of return "is really a judgment call . . . a charade of words and figures and formulas." He acknowledged, however, that "the 13.5 percent may be too low. "They have never earned the 13.5 precent. If they could, would it be too low? My own call is something in the neighborhood of 14 percent."
The SCC staff plays a major role in these rate cases by analyzing the utility's detailed data on costs and presenting its own expert witnesses to testify. But the SCC operates completely independently of the three members of the commission who, as judges, must decide the case. The staff presented testimony by William F. Beazer, a University of Virginia economics professor, who said he had studied the earnings, stock price movements and other information concerning 70 utility companies, most of which had the same "A" bond rating as Vepco.
On the basis of that analysis, he said Vepco's rate of return should be in a range of 14.1 percent to 15.15 percent. He also endorsed the notion that Vepco be allowed to earn a return near the upper end of the range if it could do so through "efficient performance."
Another expert witness, David Parcell of Technical Associates Inc. of Richmond, appearing on behalf of the state attorney general's office, used a somewhat similar analysis and came up with a range of 13.5 percent to 14.25 percent. The attorney general is charged by law to represent consumer interests at rate proceedings.
The Virginia Committee for Fair Utility Rates, which includes many of the larger industries and therefore larger users of electricity in the state, also had a set of witnesses, one of whom had yet another set of estimates for the proper rate of return.The witness, Herschel F. Jones, a senior economist with a consulting firm, CH2M HILL, recommended 15 percent.
The committee's attorney, A. C. Epps of Richmond, also noted that on the same day that Vepco filed its rate request with the SCC asking for a 16.5 percent return on its investment serving Virginians, it asked for only a 15 percent return in a filing with the Federal Energy Regulatory Commission. A FERC administrative law judge recently okayed that request.
Another major concern of the Fair Utility Rates group is the structure of rates. Their witness Jones said both small and large business customers are paying more than their share, subsidizing residential and church and synagogue customers in the process.
Pepco makes the same point, and in its recommended new rate structure wants to close one-fourth of the gap by increasing residential and church and synogogue rates by more than the 14.5 percent overall increase. Vepco says residential customers in Virginia effectively were subsidized by business customers to the tune of $56.5 million last year, while churches and synagogues got a $1.6 million subsidy. Closing part of this gap means residential rates would go up 15.4 percent and the church rates 19.9 percent.
For a typical Northern Virginia residential customer who has a heat pump for heating, that would increase his or her annual bill for 23,400 kilowatt hours from from $1,283.40 to $1,455.13, a $171.89 rise. A typical area customer who does not use electric who does not use electric heat but has air conditioning and uses about 9,600 kilowatt hours annually would pay about $72.24 more, with his or her bill going up to $689.80.
Over the years many critics of Vepco have complained that its rates have been higher than those of nearby utilities, such as Potomac Electric Power Co. in the District, Appalachian Power Co. in western Virginia, or Carolina Power and Light Co. and Duke Power Co. in North Carolina. A compilation by Vepco shows that as of this month, use of 1,000 kilowatt hours of power cost a Vepco customer $64.32. A Pepco customer would pay $71.14 for the same amount of electricity. An Appalachian customer in Roanoke would pay only $49.79. Customers of CP&L and Duke Power would pay $57.82 and $49.20 respectively.
If the pending rate increase were in effect, however, the Vepco customer would have been paying $71.18 instead of $64.32, company officials said.
Why are Vepco rates higher? There are a number of reasons, Berry says, but the biggest is the variation in the mix of fuels various utilities use to generate powers. Vepco, which led a rush to convert to oil in the 1960s, stuck its customers with the consequences of that choice. Now the customers are or will be paying for the reconversion of most of that oil-fired capcity back to coal. By 1984, Berry says, only two generating plants will still be using oil.
But a number of studies, by the SCC and FERC, have concluded that Vepco has been far less well-managed than it could have been. In recent years it has had particular trouble keeping its nuclear power plants, which have the lowest operating costs by far, on line most of the time. p
Berry told the SCC the company is in the midst of an "all-out effort" to improve its performance by reorganizing many of its operations and moving as quickly as possible away from oil.
Although Vepco officials expected to have all four of its nuclear plants operating simultaneously this weekend, after repairs on North Anna 2, the company said it would probably be next weekend before the all-plant operation comes about. It has slashed its construction program so that its capital needs have been cut greatly. Clearly, Vepco's outlook is brighter than it has been for some time, especially since it undoubtedly is going to get a significant portion of its rate increase approved by the SCC sometime next month.
From a customer's point of view, however, that monthly bill in the light blue envelope is just going to get bigger and bigger and bigger. As the U.S. Supreme Court said, and as economic reality dictates, a public utility is entitled to such rates as will permit it to earn a return. . .