Cincinnati v. Pub. Util. Comm. - Ohio Supreme Court Opinion - Ohio Supreme Court Decision

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6

OPINIONS OF THE SUPREME COURT OF OHIO

The full texts of the opinions of the Supreme Court of Ohio

are being transmitted electronically beginning May 27, 1992,

pursuant to a pilot project implemented by Chief Justice Thomas

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volumes of the Ohio Official Reports.

City of Cincinnati, Appellant, v. Public Utilities Commission of

Ohio et al., Appellees.

[Cite as Cincinnati v. Pub. Util. Comm. (1993), ___ Ohio St.3d

___.]

Public Utilities Commission -- Conversion of nuclear power plant

to coal-fired facility -- Application for rate increase --

Commission properly rejected equivalent plant standard for

valuing rate base, when -- Owner-utilities' decision to

convert to coal-fired facility found to be prudent, when --

Allowance for construction work in progress -- Amended R.C.

4909.15(A)(1) pertains only to revenues collected after

April 10, 1985 -- Court will not substitute its judgment for

that of the commission as to which of the fairly debatable

valuation periods is the most representative in determining

company's cost of common equity.

(No. 92-2101 -- Submitted June 2, 1993 -- Decided November 3,

1993.)

Appeal from the Public Utilities Commission of Ohio, No. 91-410-

EL-AIR.

In 1969, intervening appellee Cincinnati Gas & Electric

Company ("CG&E"), Columbus Southern Power Company ("CSP")

(formerly Columbus & Southern Ohio Electric Company) and Dayton

Power & Light Company ("DP&L") entered into a joint venture to

construct the William H. Zimmer Nuclear Power Station ("Zimmer").

On November 12, 1982, after numerous construction delays, the

Nuclear Regulatory Commission suspended all safety-related

construction at the site. By agreement dated January 20, 1984,

the joint owners canceled the Zimmer project as a nuclear plant

and agreed to use their best efforts to convert Zimmer to a coal-

fired facility. On August 1, 1984, they announced that Zimmer

would be converted to a 1,300 megawatt ("MW") coal-fired plant.

On October 23, 1984, appellee, Public Utilities Commission

of Ohio ("the commission"), initiated In the Matter of the

Restatement of the Accounts and Records of The Cincinnati Gas &

Electric Company, The Dayton Power & Light Company, and Columbus

& Southern Ohio Electric Company, PUCO No. 84-1187-EL-UNC, to

determine the portion of the existing Zimmer investment which may

not be used and useful in a converted coal-fired plant and/or the

impact of imprudence or mismanagement, if any, on the level of

the Zimmer investment. On October 1, 1985, the parties to that

proceeding, except appellant city of Cincinnati ("the city") and

the Board of Commissioners of Hamilton County, entered into a

stipulation which resolved that case. The stipulation generally

provided (1) that $861,000,000 of capital invested in the Zimmer

facility would be disallowed in the owner utilities' future rate

cases; (2) that the investment remaining as of January 31, 1984,

i.e., the "remaining sunk costs" (including an allowance for

funds used during construction ["AFUDC"] properly accrued thereon

subsequent to January 31, 1984), would not be challenged by the

parties as being the result of mismanagement or as not being used

and useful in a Zimmer facility converted to coal generation; (3)

that the non-owner parties reserved the right to challenge the

reasonableness of any decision subsequent to the decision to

cancel construction of Zimmer as a nuclear plant in any future

proceeding before the commission; and (4) that the total Zimmer

investment that the owners could request to be included in a

future rate proceeding would be capped at $3.6 billion. The

commission unanimously approved the stipulation on November 26,

1985, after conducting a series of public hearings as to its

reasonableness, and upon consideration of the city's testimony

and arguments opposing its adoption. The city did not appeal the

commission's order.

Zimmer was successfully converted to a 1,300 MW coal-fired

plant at a total cost of $3.069 billion and has been providing

service since March 30, 1991. On April 2, 1991, the owner

utilities each filed an application to increase their rates for

electric service, in large part to receive a return on the

respective portion of their investment in Zimmer. CG&E

requested that its jurisdictional share of the facility be fixed

at $1,216,610,000. The city was granted leave to intervene in

CG&E's rate case, and challenged CG&E's proposed Zimmer

valuation.

By its order issued May 12, 1992, the commission reduced

CG&E's requested rate-base allowance by $229,868,000,

specifically excluding improperly accrued AFUDC on the remaining

sunk costs, as well as nuclear-related costs deemed not used and

useful in the converted facility. (See the companion cases of

Cincinnati Gas & Elec. Co. v. Pub. Util. Comm. [1993], 67 Ohio

St.3d 517, 620 N.E.2d 821, and Columbus S. Power Co. v. Pub.

Util. Comm. [1993], 67 Ohio St.3d 535, 620 N.E.2d 835, decided

this date.) The commission also rejected the city's alternative

valuation proposals.

The cause is now before this court upon an appeal as a

matter of right.

__________________

Fay D. Dupuis, City Solicitor, and Richard Ganulin,

Assistant City Solicitor, for appellant.

Lee I. Fisher, Attorney General, James B. Gainer, Duane W.

Luckey, William L. Wright and Jeffrey D. Van Niel, Assistant

Attorneys General, for appellee.

Squire, Sanders & Dempsey, Alan P. Buchmann, Arthur E.

Korkosz and Lisa R. Battaglia; James J. Mayer and Michael A.

Gribler, for intervening appellee CG&E.

__________________

Per Curiam. The city argues that the commission erred: (1)

in determining Zimmer's reasonable original cost, including

failing to make a prudence adjustment to CG&E's Zimmer rate base;

and (2) in using a twelve-month average stock price to estimate

CG&E's cost of common equity. For the reasons which follow, we

reject these arguments and affirm the commission's order.

I. REASONABLE ORIGINAL COST

A. Equivalent Plant Standard

R.C. 4909.15 and 4909.051 require the commission to

ascertain the reasonable original cost of a utility's used and

useful property for ratemaking purposes. In doing so in this

case for the converted Zimmer facility, the commission separated

the cost of the plant, in accordance with the 1985 stipulation,

into four distinct parts and included in rate base: (1) the sunk

costs remaining as of January 31, 1984, which were stipulated to

be used and useful in the converted coal-fired plant; (2) the

AFUDC properly accrued on the sunk costs; (3) the portion of the

post-cancellation conversion costs (i.e., the "going forward

costs") determined to be used and useful in this proceeding; and

(4) the AFUDC on those costs. While the city concedes that the

commission properly determined the reasonableness of the used and

useful conversion costs and associated AFUDC in this proceeding,

it contends that the commission erred by not considering the

reasonableness of the otherwise allowable sunk costs. The

commission and CG&E generally contend that such a reasonableness

analysis of the remaining sunk costs is prohibited by the 1985

stipulation. We agree.

The stipulation was crafted to provide for a dollar

disallowance for "nuclear" Zimmer, rather than a consideration of

specific plant items, in order to accommodate settlement and to

avoid the need for an arduous "brick by brick" audit of specific

plant items. Accordingly, the stipulation does not distinguish

between the specific plant items deemed used and useful in a

converted Zimmer facility, and those which were included in the

$861 million disallowance. There being no means to identify or

challenge the pre-January 31, 1984 plant stipulated to be used

and useful in a converted Zimmer, it necessarily follows that the

stipulation prohibits inquiry into the "reasonableness" of these

otherwise allowable sunk costs. Indeed, in its 1985 order

approving the stipulation, the commission recognized that only

the reasonableness of the "going forward costs to complete the

converted [Zimmer] facility" were left open to challenge in the

instant proceeding. The city did not appeal that order and is now

bound by it.

Recognizing that the specific plant items represented by the

sunk costs are beyond review in this proceeding, the city based

its alternative Zimmer valuation (including the remaining sunk

costs and the conversion costs) upon the present value of the

allegedly comparable Rockport Power Plant in Indiana.2 The

commission rejected the city's proposal as being contrary to the

original cost rate-base valuation required by R.C. 4909.05.

We have recognized that a utility's rate base under the

original-cost standard is based upon the actual investment in the

assets of the utility. Babbit v. Pub. Util. Comm. (1979), 59

Ohio St.2d 81, 89-90, 13 O.O.3d 67, 72, 391 N.E.2d 1376, 1381;

Franklin Cty. Welfare Rights Org. v. Pub. Util. Comm. (1978), 55

Ohio St.2d 1, 11, 9 O.O.3d 1, 6, 377 N.E.2d 990, 997. Clearly,

the city's proposed Zimmer rate-base valuation, based upon the

cost of an allegedly comparable plant adjusted to price levels at

the time of valuation, violates the statutory original cost

standard and is unlawful under R.C. 4909.05(E).3

The city also argues that the AFUDC accrued on the remaining

sunk costs is not a "reasonable" cost of Zimmer and should be

excluded in its entirety from rate base. As set forth more fully

in the companion cases of Columbus S. Power, supra, and

Cincinnati Gas & Elec. Co., supra, the 1985 stipulation

explicitly provided for the allowance of such AFUDC in this

proceeding, subject only to its "proper accrual" under

established accounting conventions. Having determined in those

cases that the commission's allowance of AFUDC on these sunk

costs from March 1986 until completion of the Zimmer facility was

neither unreasonable nor unlawful, we reject this argument.

Accordingly, we conclude that the commission properly

rejected the city's equivalent-plant standard for valuing rate

base and that it properly determined Zimmer's valuation within

the constraints imposed by the 1985 stipulation.

B. Prudence

While the 1985 stipulation prevented inquiry into the

reasonableness of the remaining sunk costs, it expressly left

open to challenge in this proceeding whether the owner-utilities'

decision to convert Zimmer to a coal-fired facility was prudent.

We adopt the commission's definition of a prudent decision,

which is in accord with that used in other jurisdictions,4 as

"one which reflects what a reasonable person would have done in

light of conditions and circumstances which were known or

reasonably should have been known at the time the decision was

made." In the Matter of the Investigation into the Perry Nuclear

Power Station (Jan. 12, 1988), PUCO No. 85-521-EL-COI, at 10-11.

The standard contemplates a retrospective, factual inquiry,

without the use of hindsight judgment, into the decisionmaking

process of the utility's management. See Re Syracuse Home Util.

Co. (Dec. 30, 1986), PUCO No. 86-12-GA-GCR; Re Toledo Edison Co.

(July 16, 1987), PUCO No. 86-05-EL-EFC.

The issue central to the prudence inquiry below was whether

CG&E, in 1984, could have written off its entire Zimmer

investment and still have had sufficient access to the capital

markets to enable it to construct an arguably less costly

generating facility in time to meet its customers' forecasted

energy needs in 1991. The construction options under

consideration included, inter alia, building a coal-fired plant

at a new ("greenfield") site or adding an additional coal-fired

generating unit at an existing facility, owned by CG&E and DP&L,

at East Bend, Kentucky.

Although the commission found that CG&E's decisionmaking

process was "less than adequate," and made a corresponding

downward adjustment to the company's rate of return, it refused

to make a prudence adjustment to CG&E's Zimmer rate base.

Specifically, the commission found that an adjustment was not

warranted because the rate-base exclusions related to AFUDC,

nuclear fuel, and nuclear wind-down costs (nearly $230 million in

this case), as well as the $861 million disallowance required by

the 1985 stipulation (approximately $400 million in this case),

reduced Zimmer's valuation to the range of costs to construct an

alternative plant at a greenfield site. Further, it found that

the East Bend option was not a viable alternative, primarily

because CSP did not own an interest in the site and also because

CG&E's abandonment of its contractual obligation to pursue

construction at Zimmer could have resulted in costly and

extensive litigation, the outcome of which would be uncertain.

By this appeal, the city argues that East Bend was a viable,

lower-cost alternative to Zimmer's conversion, that a prudent

utility manager would have selected that option over conversion

of the nuclear facility, and that the Zimmer rate-base valuation

should be reduced to the East Bend unit's cost of construction.

The narrow question presented, whether East Bend is a viable

alternative, is one of fact. On questions of fact, this court

will not reverse an order of the commission absent a showing that

it is manifestly against the weight of the evidence, and is so

unsupported by the record as to show misapprehension, mistake, or

willful disregard of duty. MCI Telecommunications Corp. v. Pub.

Util. Comm. (1988), 38 Ohio St.3d 266, 268, 527 N.E.2d 777, 780.

We begin our review by noting that, having embarked on a

joint venture to construct the Zimmer nuclear facility, the owner-

utilities could not have considered the alternatives to

completion of that facility in a vacuum. It is undisputed on the

record in this proceeding that, in 1984, the joint owners

collectively needed the 1,300 MW of electricity that a converted

Zimmer facility would provide to meet their customers' forecasted

energy needs in 1991.5 Obviously, had any one of the owner-

utilities unilaterally abandoned its Zimmer commitment,

protracted litigation could have followed, which, as it pertains

to this issue, could not only have affected CG&E's financial

ability to pursue the East Bend option but, just as important,

could have prevented completion of that facility in time to meet

its customers' forecasted energy needs.

The city argues that CG&E could have completed an East Bend

facility in 1991 to replace the capacity that otherwise would

have been provided by the converted Zimmer facility. It relies

on the testimony of its expert financial witness that it was

feasible for the company to accelerate completion of the East

Bend unit from 1998 (as assumed by a study conducted by the First

Boston Corporation for CG&E) to 1991. However, the witness's

testimony addressed only the financial feasibility of

accelerating construction and admittedly did not take into

consideration the company's capacity needs for the 1980s and

1990s, or the engineering, contractual and legal impediments to

selecting that site. CG&E's witness testified that, assuming

these barriers were overcome, and even assuming the absence of

financial constraints in constructing a unit at East Bend, the

unit could not have been placed in service until 1995 or later

due, in part, to state (Ohio and Kentucky) and federal licensing

and permitting requirements.

The city also argues that sufficient blocks of power could

have been purchased from other utilities and were available for

1991 to meet CG&E's customers' energy needs until the East Bend

unit was placed into service. However, the city's witness on

this issue admitted that his conclusion, based on 1991

forecasted data, relied upon hindsight judgment and was not

intended as a part of a prudence analysis of what the utilities

knew or should have known at the time the decision to convert

was made. According to the company's analyses and the analyses

of the commission's staff, based upon data available at the time

the decision to convert was made, such large amounts of bulk

power had an uncertain availability for the 1990s and beyond due

to existing low reserves in surrounding regions, the anticipated

curtailment of generation expansion and the effects of acid rain

legislation.6

We find that the record supports the commission's

determination that the East Bend option was not a viable

alternative to Zimmer's conversion and reject the city's

proposition of law.

C. CWIP Offset

Between 1980 and 1983, the commission granted CG&E an

allowance for construction work in progress ("CWIP") related to

Zimmer's construction as a nuclear facility. There is no dispute

that these allowances were lawful under then-existing R.C.

4909.15(A)(1), or that they were collected by CG&E by April 11,

1983.

The city argues that the commission erred by not using these

lawfully authorized and lawfully collected revenues to offset

CG&E's rate base in this proceeding. While R.C. 4909.15(A)(1)

was amended in 1985 to provide for such offsets, it pertains only

to revenues collected after April 10, 1985. Am.Sub.S.B. No. 27,

140 Ohio Laws, Part I, 58. There being no authority to offset

the revenues in question, we reject the city's argument.

II. RATE OF RETURN

The issue presented by the city's final proposition of law

is whether it was reasonable for the commission to use CG&E's

average test-year stock price, as recommended by its staff, in

determining CG&E's cost of common equity and, ultimately, its

overall rate of return.7 The city points to the rise in CG&E's

stock price during the second half of 1991 and argues that the

first six months' data is unrepresentative of current market

trends and conditions. It argues that either the six-month or

twelve-month average as of the issuance of the commission's May

12, 1992 order is more representative and should have been

adopted by the commission. The commission found that the city's

recommendation was based upon post-record data and refused to

adopt it. We find the commission's determination to be neither

unreasonable nor unlawful.

Alternatively, the city argues that the six-month average as

of the close of hearing in mid-February 1992 should have been

adopted as being more representative. The commission rejected

the various short-term valuation periods (ranging from one to six

months) recommended by the experts testifying on this issue,

noting that it traditionally uses a twelve-month average in order

to minimize the effects of short-term market fluctuations.

Finding no anomalous conditions (e.g., a stock price break or

market break) which would make the twelve-month average

unrepresentative in this proceeding, the commission adopted its

staff's recommendation.

We refuse to substitute our judgment for that of the

commission as to which of the fairly debatable valuation periods

is the most representative in determining the company's cost of

common equity. See AT&T Communications of Ohio, Inc. v. Pub.

Util. Comm. (1990), 51 Ohio St.3d 150, 555 N.E.2d 288; Cleveland

Elec. Illum. Co. v. Pub. Util. Comm. (1976), 46 Ohio St.2d 105,

75 O.O.2d 172, 346 N.E.2d 778. The commission's determination,

based upon its staff's recommendation, is supported by the record

and is neither unreasonable nor unlawful. Accordingly, we affirm

the decision of the commission on this issue.

Order affirmed.

Moyer, C.J., A.W. Sweeney, Douglas, Wright, Resnick, F.E.

Sweeney and Pfeifer, JJ., concur.

FOOTNOTES:

1. R.C. 4909.15(A)(1) requires the commission, in fixing rates,

to determine "[t]he valuation as of the date certain of the

property of the public utility used and useful in rendering the

public utility service for which rates are to be fixed and

determined. The valuation so determined shall be the total value

as set forth in division (J) of section 4909.05 of the Revised

Code.* * *"

R.C. 4909.05(J) provides that the valuation of a utility's

property shall include the original cost of long-term assets

(R.C. 4909.05[C], [D], [E], [F], and [G]) less depreciation and

contributions of capital (R.C. 4909.05[H] and [I]). The Zimmer

investment at issue falls under R.C. 4909.05(E), which provides

that the "original cost" of such property "shall be the cost, as

determined to be reasonable by the commission, to the person that

first dedicated the property to the public use and shall be set

forth in property accounts and subaccounts as prescribed by the

commission.* * *"

2. The city also alleges that the commission used such an

"empirical benchmark," albeit an erroneous one, in determining

Zimmer's valuation. While the commission considered the cost to

construct an alternative plant, it did so in the context of

determining whether a further rate-base adjustment should be made

when considering the prudence of CG&E's decision to convert, not

in considering whether the specific costs to construct Zimmer

were reasonable.

3. Three general methods are recognized in valuing utility

property: (1) original cost, which values existing plant and

additions based upon the actual cost to the person that first

dedicated the property to the public use; (2) reproduction cost

new ("RCN"), which values existing plant and additions at the

estimated price levels prevailing at the date of valuation; and

(3) fair value, which considers a property's original cost and

current value, sometimes assigning weights to the two. See

Phillips, The Regulation of Public Utilities (2 Ed.1988) 304,

324; Priest, Principles of Public Utility Regulation (1969) 140-

141; Rose, Confusion in Valuation for Public Utility Rate-making

(1962), 47 Minn.L.Rev. 1. The city's alternative valuation is

more akin to the RCN standard, which was formerly prescribed by

Ohio statute, but which has been replaced by the original cost

standard in 1976. See Babbit, supra, 59 Ohio St.2d at 89, 13

O.O.3d at 72, 391 N.E.2d at 1381.

4. See Phillips, The Regulation of Public Utilities (2 Ed.1988)

326.

5. CG&E's share of the converted Zimmer is approximately 600

MW, DP&L's share is approximately 325 MW, and CSP's share is

approximately 375 MW.

6. The city also points to other references in the record as to

the availability of purchased power. Specifically, it argues

that American Electric Power Corporation (CSP's parent) had

arranged to provide CG&E with backup power; however, that offer

was made as a part of the January 20, 1984 agreement to convert

Zimmer and extended only during the term of Zimmer's

construction. The city also points to a power sale proposal from

the Tennessee Valley Authority; however, the record does not

reflect that the proposal would satisfy the amount or duration of

power needed by CG&E, not to mention the needs of the other

owners. Finally, the city notes three other power sales in the

region executed in 1981, 1987 and 1990. Of course, the 1981 sale

could not be considered as available for CG&E and the other

owners at the time the decision to convert was made, and the

availability of the latter two are based upon a hindsight

analysis. None provided the amounts of power needed as a Zimmer

replacement.

7. In determining the cost of common equity, the commission

customarily, as here, employs the discounted cash flow ("DCF")

model which, generally stated, estimates the required cost of

common equity by adding the current dividend yield (dividend

divided by representative stock price) and expected dividend

growth rate.