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In re Kansas City Power & Light Company's v. Missouri Public Service Commission

Court of Appeals of Missouri, Western District, Second Division

September 6, 2016


         Appeal from the Public Service Commission

          Before: Karen King Mitchell, Presiding Judge, Cynthia L. Martin, Judge and Gary D. Witt, Judge

          Gary D. Witt, Judge.

         This case consolidates two appeals from a rate case involving Kansas City Power & Light Company's ("KCPL") request for a rate increase from the Public Service Commission ("PSC"). KCPL appeals from the Report and Order ("Report and Order") of the PSC in its most recent general rate case, pursuant to Section 386.510.[1] KCPL raises five points on appeal, challenging the return on equity granted by the PSC, the methods used to calculate that rate of return, the rejection of a "tracker" accounting mechanism, the PSC's refusal to include certain transmission costs in a fuel adjustment clause, and the denial of certain rate case expenses. We affirm the PSC's Report and Order.

         Midwest Energy Consumers' Group ("MECG") is an unincorporated association that is comprised of large consumers of energy, which was permitted to intervene in KCPL's rate case. MECG appeals from the Compliance Tariff Order, which implemented the Report and Order. MECG raises seven points of error, each challenging the September 16 Compliance Tariff Order that concluded the Final Compliance Tariff sheets filed by KCPL complied with the PSC's September 2 Report and Order. Each point of error challenges the process and procedure by which the PSC issued its Compliance Tariff Order. MECG's appeal is dismissed as moot.

         Factual Background

         KCPL is a regulated public utility under the jurisdiction of the PSC of the State of Missouri under Chapters 386 and 393. The PSC is charged with the authority to set the rates that KCPL is allowed to charge consumers pursuant to section 393.150. On October 30, 2014, KCPL filed tariff sheets that would implement a general rate increase for its retail electric utility service. KCPL requested an increase on its return on equity from 9.7% to 10.3%. In addition, KCPL asked the PSC to adopt a fuel adjustment clause under section 386.266 and to use an accounting deferral mechanism for certain items of expenditure.

         The implementation of the new tariffs was suspended until September 29, 2015 to allow for full rate case proceedings. A number of parties intervened and participated in the proceedings, including MECG. A test year of twelve months, ending on March 31, 2014 and extended to December 31, 2014, was agreed to by the parties and adopted by the PSC. The PSC also established a "true-up" period to run through May 31, 2015. Public hearings were conducted and evidentiary hearings were held over a number of days. The parties filed post-hearing briefs and the case was submitted to the PSC on August 3, 2015.

         In its Report and Order, the PSC set KCPL's return on equity to 9.5%. The PSC denied KCPL's request for an accounting deferral mechanism known as a "tracker" for certain expenses. The PSC permitted KCPL to implement a fuel adjustment clause, but only for "true" purchased power, approximately 7.3% of the costs charged to KCPL by the Southwest Power Pool. Finally, the PSC allowed KCPL to recover approximately 74.26% of its expenses on the rate case. Timely applications for rehearing were filed and denied.

         This appeal follows. Further details regarding the relevant disputed issues are outlined as applicable in the analysis sections of each point below.

          Standard of Review

         An order from the PSC is presumed to be valid, and the burden of proof is on the party challenging the order, by clear and satisfactory evidence, to show that the order is either unlawful or unreasonable. See In re Laclede Gas Co., 417 S.W.3d 815, 819 (Mo. App. W.D. 2014); Section 386.430.

         Judicial review of the PSC's Report and Order is two-fold. State ex rel. Pub. Counsel v. Pub. Serv. Comm'n, 397 S.W.3d 441, 446 (Mo. App. W.D. 2013). First, we must determine whether the PSC's order was lawful. Id.

An order's lawfulness depends on whether the [PSC's] order and decision was statutorily authorized. When determining whether the order is lawful, we exercise independent judgment and must correct erroneous interpretations of the law. Because the [PSC] is purely a creature of statute, its powers are limited to those conferred by statute either expressly, or by clear implication as necessary to carry out the powers specifically granted.

Id. at 446-47 (internal quotations and citations omitted). "Second, we must determine whether the [PSC's] order was reasonable." Id. at 447. "In determining whether the Commission's order is reasonable, we consider (1) whether it was support[ed] by substantial and competent evidence on the whole record, (2) whether the decision was arbitrary, capricious, or unreasonable, and (3) whether the [PSC] abused its discretion." Id. (internal quotations and footnote omitted).

"We consider the evidence, along with all reasonable supporting inferences, in the light most favorable to the Commission's order. [State ex rel. Mo. Gas Energy v. Pub. Serv. Comm'n, 186 S.W.3d 376, 382 (Mo. App. W.D. 2005).] "[I]f substantial evidence supports either of two conflicting factual conclusions, '[we are] bound by the findings of the administrative tribunal.'" State ex rel. AG Processing, Inc. v. Pub. Serv. Comm'n, 120 S.W.3d 732, 735 (Mo. banc 2003) (quoting Amway Corp. v. Dir. of Revenue, 794 S.W.2d 666, 668 (Mo. banc 1990)). The determination of witness credibility is left to the Commission, '"which is free to believe none, part, or all of the testimony."' Mo. Gas Energy, 186 S.W.3d at 382 (quoting Commerce Bank, N.A. v. Blasdel, 141 S.W.3d 434, 456-57 n.19 (Mo. App. W.D. 2004)). "It is only where a Commission order is clearly contrary to the overwhelming weight of the evidence that we may set it aside." Id. Additionally, with regard to issues within the Commission's expertise, "we will not substitute our judgment for that of the Commission." [Union Elec. Co. v. Pub. Serv. Comm'n, 136 S.W.3d 146, 151 (Mo. App. W.D. 2004)].

State exrel. Pub. Counsel v. Mo. Pub. Serv. Comm'n, 289 S.W.3d 240, 246-47 (Mo. App. W.D. 2009).

         Appeal by Kansas City Power & Light Company


         Point One - Return on Equity

         In KCPL's Point One on appeal, KCPL argues the PSC erred in choosing a return on equity ("ROE") of 9.5% and in refusing regulatory treatment that recognizes certain known future cost increases because the impact of these determinations is unreasonable and unlawful as it is confiscatory.

         The Supreme Court has decided that a public utility, as a matter of constitutional right,

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 are realized or anticipated in highly profitable enterprises or speculative ventures. The return should be reasonably sufficient to assure confidence in the financial soundness of the utility and should be adequate, under efficient and economical management, to maintain and support its credit and enable it to raise the money necessary for the proper discharge of its public duties.

Bluefield Waterworks & Improvement Co. v. Pub. Serv. Comm'n of W.Va., 262 U.S. 679, 692-93 (1923). "A rate of return is generally considered to be fair if it covers utility operating expenses, debt service, and dividends, if it compensates investors for the risks of investment, and if it is sufficient to attract capital and assure confidence in the enterprise's financial integrity." State ex rel. Mo. Gas Energy, 186 S.W.3d at 383 (internal quotation omitted); see also Fed. Power Comm'n v. Hope Nat. Gas Co., 320 U.S. 591, 603(1944).

         In Missouri, section 393.270.4 governs, in part, the PSC's authority to fix utility rates, and states the following:

In determining the price to be charged for gas, electricity, or water the commission may consider all facts which in its judgment have any bearing upon a proper determination of the question although not set forth in the complaint and not within the allegations contained therein, with due regard, among other things, to a reasonable average return upon capital actually expended and to the necessity of making reservations out of income for surplus and contingencies.

         "The rate of return is, essentially, the amount that a utility must pay to secure financing from debt and equity investors." State ex rel. Pub. Counsel v. Pub. Serv. Comm'n, 274 S.W.3d 569, 573 (Mo. App. W.D. 2009). "To determine the proper rate of return, the commission should factor '(i) the ratio of debt and equity to total capital, and (ii) the cost and (iii) weighted cost for each of these capital components.'" Id. at 573-74 (quoting State ex rel. Mo. Gas Energy, 186 S.W.3d at 383).

         "Determining a rate of return on equity, however, is imprecise and involves balancing a utility's need to compensate investors against its need to keep prices low for consumers." Id. at 574. Missouri courts have consistently held that the PSC is not required to utilize any specific methodology to calculate a just and reasonable return in setting rates. State ex rel. Praxair, Inc. v. Pub. Serv. Comm'n, 328 S.W.3d 329, 339 (Mo. App. W.D. 2010). This Court has outlined the following principles governing review of the PSC's determination of an ROE.

The Commission has considerable discretion in rate setting due to the inherent complexities involved in the rate setting process. State ex rel. Associated Natural Gas Co. v. Public Serv. Comm'n, 706 S.W.2d 870 (Mo.App.1985). It is not the theory or methodology, but the impact of the rate order which counts. State ex rel. Missouri Water Co. v. Public Serv. Comm'n, 308 S.W.2d 704, 714 (Mo. 1957). Missouri courts do not set utility rates. State ex rel. GTE North, Inc. v. Missouri Pub. Serv. Comm'n, 835 S.W.2d 356, 361 (Mo.App.1992). "If the total effect of the rate order cannot be said to be unjust and unreasonable, judicial inquiry under the Act is at an end." Associated Natural Gas, 706 S.W.2d at 873 (quoting Federal Power Comm'n v. Hope Natural Gas Co., 320 U.S. 591, 602-03, 64 S.Ct. 281, 287-88, 88 L.Ed. 333 (1944)). Where ratemaking is at issue, determinations by the Commission are favored by a presumption of validity.

State ex rel. Office of the Pub. Counsel v. Pub. Serv. Comm'n, 938 S.W.2d 339, 344 (Mo. App. W.D. 1997).

         The PSC set KCPL's ROE at 9.5%, down from the previous return on equity of 9.7%. KCPL had requested a new return on equity rate at somewhere between 9.7% and 10.3%. There is not a single way to determine a proper ROE. Therefore, analysts utilize three generally accepted methods to estimate a fair ROE: the Discount Cash Flow Method ("DCF"), the Risk Premium Method, and the Capital Asset Pricing Method ("CAPM").[2] Analysts generally balance their use of all three methods to determine a recommended ROE.

         Four expert witnesses testified as to their opinions regarding the ROE. One witness, Robert Hevert ("Hevert"), offered testimony on behalf of KCPL. He recommended an ROE of 10.3%, within a range of 10.0% to 10.6%. The PSC determined that Hevert's estimate was too high. The PSC found Hevert's (1) constant growth DCF results were based on excessive and unsustainable long-term growth rates, (2) multi-stage DCF was based on a flawed accelerating dividend cash flow timing and an inflated gross domestic product growth estimate as a proxy for long-term sustainable growth, (3) CAPM was based on inflated market risk premiums, and (4) bond yield plus risk premium was based on inflated equity risk premiums.

         Michael Gorman ("Gorman") testified on behalf of the Missouri Industrial Energy Consumers and MECG. He testified that based on returns on equity awarded by other commissions, a reasonable ROE for KCPL would be 9.5% or less. He recommended an ROE of 9.1% within a range of 8.8% and 9.4%. Maureen Reno ("Reno") offered testimony on behalf of the U.S. Department of Energy and the Federal Executive Agencies and recommended an ROE of 9.0% within a recommended range of 8.2% and 9.6%. Finally, Zephania Marevangepo ("Marevangepo") offered testimony on behalf of the technical staff of the PSC. She recommended an ROE of 9.25% within range of 9.0% and 9.5%.

         The PSC found the estimates from Gorman, Reno, and Marevangepo were reasonable and accurate estimates of the current market cost of capital for KCPL. The upper ends of the recommendations from these three analysts were 9.4% to 9.6%. The PSC concluded that these recommendations relied on verifiable and independent market data and accepted market-based rate of return models. The PSC also considered a number of additional factors, including recent indicators of growth and the reduction of risk to KCPL by the PSC's approval of a fuel adjustment clause, which would support a reduced return. KCPL found that an ROE of 9.5% would allow KCPL to compete in the capital market for funds needed to maintain its financial health.

         To further justify its chosen ROE of 9.5%, the PSC found that, in general, state public utility commissions are reducing authorized returns on equity to follow declines in capital market costs. The PSC looked at industry authorized returns on equity for fully litigated cases, which in 2014 was 9.63% and in the first quarter of 2015 was 9.57%. The PSC uses these comparisons because KCPL must compete with other utilities in the country for the same capital. Since the last established ROE of 9.10%, the PSC found that market capital costs for Missouri electric utilities are lower as a result of increases in stock prices and decreases in bond yields and utility dividend yields. In addition, since April of 2015, capital markets and general economic indicators have indicated expanding macroeconomic growth and increasing returns.

          KCPL, on the other hand, argues that the PSC made its decision contrary to evidence of a consistent pattern of KCPL earning below its authorized ROE. KCPL presented evidence that U.S. regulatory commissions were approving ROEs that averaged 9.83% during the second quarter of 2015. KCPL also argued that it has a riskier profile than most other U.S. utilities that would justify a higher ROE. KCPL takes issue with the approach taken by the PSC to determine the ROE by relying on historical costs to set rates. KCPL argues that the PSC's reliance on historical data will fail to reflect KCPL's current expenses when the new rates take effect, which KCPL claims will be higher than historical costs indicate due to a number of factors, a phenomenon called "regulatory lag."

         The PSC counters that its approach to calculating the ROE strikes the appropriate balance between considering historical costs in setting the ROE and looking at future variables. The test year is the primary mechanism through which the PSC determines appropriate rates. The PSC focuses on four factors during the test year: (1) the rate of return the utility has an opportunity to earn; (2) the rate base upon which a return may be earned; (3) the depreciation costs of plant and equipment; and (4) allowable operating expenses. These factors are considered to determine the utility's revenue requirement, which is the amount of revenue taxpayers must generate to pay the costs of producing the utility's services they receive while yielding a reasonable rate of return. The PSC's use of a true-up audit and hearing is designed to balance the historical data with known and measureable subsequent and future changes; these are generally limited only to accounts affected by a significant known and measurable change, such as a new labor contract, new tax rate, or the completion of a new capital asset. This procedure is designed to reduce regulatory lag.

         This Court's role is not to determine what a reasonable ROE is but rather to review the record to see if the PSC's decision is lawful and supported by competent and substantial evidence. State ex rel. Pub. Counsel, 397 S.W.3d at 447. We must defer to the Commission's decisions regarding the credibility of witnesses and not second-guess issues that are within the PSC's area of expertise. See State ex rel. Pub. Counsel, 289 S.W.3dat247.

Evaluation of expert testimony is left to the Commission which "may adopt or reject any or all of any witnesses' testimony." State ex rel. Associated Natural Gas Co. v. Public Service Comm'n, 706 S.W.2d 870, 880 (Mo. App. W.D. 1985). Since the testimony of both experts was properly presented to the Commission, it was up to the Commission to choose between the conflicting evidence presented as to the propriety of including the cost of the storage gas in the new rate calculations.

State ex rel. Associated Nat. Gas Co. v. Pub. Serv. Comm'n, 37 S.W.3d 287, 294 (Mo. App. W.D. 2000).

         We find that the decision of the PSC was lawful and supported by competent and substantial evidence. First, three experts each testified credibly, as found by the PSC, as to an appropriate ROE. The chosen ROE of 9.5% was within the ranges of the recommendations of these three experts. The PSC found the testimony of expert Gorman credible that an ROE as low as 9.1% would maintain KCPL's financial integrity and ability to attract capital. Gorman's analysis included an evaluation of the risks and uncertainties faced by utilities comparable to KCPL, thus complying with the Supreme Court's guidance in Bluefield. See Bluefield Waterworks, 262 U.S. at 692. Further, the PSC determined that an ROE of 9.5% was close to the average of comparable utilities, which in 2014 was 9.63% and in the first quarter of 2015 was 9.57%. This Court has previously approved a "zone of reasonableness" established by the PSC that considered a return on equity within 100 basis points (i.e. 1.0% above or below) the national average as presumptively reasonable. See State ex rel. Pub. Counsel, 274 S.W.3d at 574; In re Permian Basin Area Rate Cases, 390 U.S. 747, 767 (1968)("courts are without authority to set aside any rate selected by the Commission [that] is within a 'zone of reasonableness'"). Here, the zone of reasonableness within the national average, as found by the PSC, is 8.63% to 10.63%. An ROE of 9.5% falls squarely within the zone of reasonableness. Also, we have held that where the ROE falls within the range recommended by the expert witnesses and is in keeping with the average for other similarly situated entities, in the absence of any other significant showing that the figure established is unreasonable, this Court must defer to the PSC. See State ex rel. Noranda Aluminum, Inc. v. Pub. Serv. Comm'n, 356 S.W.3d293, 311 (Mo. App. S.D. 2011).

         Although KCPL complains that the PSC only looked to "fully-litigated" cases rather than to all other rate cases to determine comparable returns on equity, KCPL has cited no authority that would suggest the PSC's reliance on fully-litigated cases is improper. Our role is not to second-guess issues that are within the PSC's area of expertise and we will not do so here. See State ex rel. Pub. Counsel, 289 S.W.3d at 246-47. KCPL relies extensively on past actual returns on equity to argue reducing its ROE here is unreasonable, but such comparisons are only of limited value as the PSC cannot compensate KCPL for previous unearned equity but may only use that information in its calculations of a reasonable return going forward. See State ex rel Mo. Gas Energy, 186 S.W.3d at 383 (the law does not require that rates yield any particular return and past losses are not considered in deciding whether a new rate is confiscatory).

         Second, although KCPL complains that the historical test-year model with a true-up period does not adequately take into account regulatory lag, the PSC has adapted its methodology to attempt to account for regulatory lag. The true-up period established by the PSC was designed to remediate some of the negative effects of regulatory lag by taking into account known and measurable subsequent or future changes to KCPL's expenses. Again, the PSC is not obligated to use any set methodology in making its ROE determinations but must exercise its considerable discretion and expertise in finding an ROE that is just and reasonable. See State ex rel. Praxair, Inc., 328 S.W.3d at 339. Determinations of the PSC have the presumption of validity that will not be upended for the sole reasons that KCPL believes it has a better way to calculate an ROE. Id. ("Where ratemaking is at issue, determinations by the [PSC] are favored by a presumption of validity.") The best way to account for regulatory lag is a question of methodology and is best addressed by the expertise of the PSC, which this Court will not second-guess. See State ex rel. Pub. Counsel, 289 S.W.3d at 246-47.

         We find that KCPL's chosen return on equity was lawful and supported by substantial and competent evidence. Point One is denied.

         Points Two and Three - Tracking Mechanisms and Forecasts

         KCPL's claims in Points Two and Three on appeal are largely intertwined and, therefore, will be considered together. In its case in chief and in direct testimony, KCPL requested that the PSC grant it the use of tracking mechanisms[3] for expenses related to certain transmission fee expenses, property tax expenses, and CIP/cyber-security expenses. In sur-rebuttal testimony, KCPL suggested, in the alternative to the requested tracking mechanisms for these expenses, in the event those mechanisms were denied by the PSC, that its estimates of future expenses regarding the above categories be added to the figures from which the PSC calculates KCPL's revenue requirements.

         The PSC denied KCPL's request to use tracking mechanisms as to each of these categories of expenses. This is the subject of KCPL's Point Three on appeal, considered first, in which KCPL claims the PSC erred in denying its request for a "tracker" accounting deferral mechanism because the legal conclusion by the PSC that only "extraordinary" items could be deferred as regulatory assets is unlawful and unreasonable because it is contrary to the Uniform System of Accounts ("USOA"), adopted by the PSC, because the USOA does not require that revenues, expenses, gains or losses be "extraordinary" in order to be deferred as a regulatory asset or liability.

         The PSC has the power, pursuant to section 393.140(4), to prescribe uniform methods of keeping accounts. The PSC has adopted a rule that requires utilities to use the USOA to maintain their books and records. See 4 CSR 240-20.030. KCPL's arguments regarding the USOA and its alleged right to use a tracking accounting deferral mechanism completely ignore that the PSC's decision that only extraordinary expenses should be allowed such treatment is a policy decision that has been made by the PSC and is not dictated by whether, in the abstract, the USOA provides a mechanism to defer costs, whatever the type. The PSC has decided that the "use of trackers should be limited because they violate the matching principle, tend to unreasonably skew ratemaking results, and dull the incentives a utility has to operate efficiently and productively under the rate regulation approach employed in Missouri." The manager of the PSC's auditing unit testified that the PSC will issue accounting authority orders ("AAOs"), which serve to allow a utility to deviate the normal method of accounting for certain expenses, most often associated with "extraordinary" events. The request by KCPL for the "tracking" accounting mechanism is the same as a request for an AAO, as it seeks to book a particular cost, normally charged as an expense on a utility's income statement in the current period, to the utility's balance sheet as a regulatory asset or regulatory liability. The manager testified that the PSC

in prior cases has stated that the standards for granting the authority to a utility to defer costs incurred outside of a test year as a regulatory asset are: 1) that the costs pertain to an event that is extraordinary, unusual and unique, and not recurring; ...

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