The D.C. Public Service Commission yesterday upheld the right of the Potomac Electric Power Co. to continue using a price escalator on its monthly bills to District of Columbia customers to recover the rising cost of the fuel it uses to produce electricity.

However, in its 43-page order, the PSC said it would set up a new procedure under which Pepco's fuel price adjustments will be reviewed and audited, with the public permitted to participate. At present, there is no public audit process.

The ruling does not affect the traditional procedure under which public hearings are held on periodic applications by Pepco and other utility firms to establish the basic rates that they may charge to pay for overhead operating costs and establish the allowable return on corporate investment.

Yesterday's PSC decision ended an 18-month inquiry begun by the PSC itself to see whether Pepco's escalator clause conformed to national standards and legal requirements. Pepco has had such a clause in various forms since 1947, and its present escalator permitting a monthly adjustment when coal and oil prices rise -- or occasionally fall -- has been in effect since 1971.

At present, the use of such clauses by utlity firms are permitted in varying forms by the Federal Energy Regulatory Commission and 43 states, including Maryland and Virginia. Legislation to eliminate the clause here has been introduced in the D.C. City Council