IV. The Treatment of Gains by other States

The majority of public service commissions in other states treat gains on the sale of utility assets on a case-by-case basis. Others have specified policies, such as giving all gains to ratepayers, giving all to shareholders, or dividing the gains in some proportion. In 1994, the National Regulatory Research Institute (NRRI) surveyed the states to determine what patterns exist in the treatment of gains.⁶ These are the major findings of this study:

9. Out of 49 responses, 37 state commissions stated that they have no generic policy and treat the disposition of the gain on a case-by-case basis, while 10 specified policies.

10. Five of the 10 state commissions with specific policies allocate the gain to ratepayers, one allocates the gain to shareholders, and two always split the gain between the two. Two states give the gain to ratepayers under specified circumstances, and give the gain to shareholders under other specified circumstances.

11. Overall, the majority of the gain is allocated to ratepayers, although in about half the cases the shareholders are given some of the gain.

12. The gain given to ratepayers is usually provided as an offset to the revenue requirement, although sometimes it is given as a reduction to the ratebase.

5. The most common rationale cited for allocating the gain is whether the asset was in ratebase during its use. Other reasons cited were:

· Judicial, statute, or commission precedent. The P.U. Code does not guide the Commission regarding the allocation of the gain, except for water companies as specified in P.U. Code Sections 789, et seq. See below for a discussion of these Code sections. Also see below for a discussion of some major Commission decisions covering the appropriate allocation of the gains.

· Who bore the risk? The risk of financial loss from the investment is borne by either the shareholder, ratepayer, or both. As a reward for bearing this risk, that party is given the gain. Sometimes the definition of risk is broadened to include the possibility of lowered levels of service to ratepayers, or the possibility of entry into the market by competitors.

· Is the asset depreciable? Land is not depreciable, whereas capital wears out and is thus depreciable. If the asset in question is land, shareholders do not receive depreciation payments in rates. However, ratepayers provide a return on the original cost of the land for as long as it is in ratebase, and continue to pay for carrying costs.

· The Uniform System of Accounts (USOA). The Commission's USOA provides accounting instructions for plant assets including depreciation allowance and retirement. The Commission adopts the straight line remaining life depreciation method for the cost recovery of plant investment. If the utility plant serves out its useful life as anticipated, ratepayers will pay the investors their cost of investment through depreciation and a return on the undepreciated balance during the remaining life of the plant.

· The usefulness of the USOA is limited only to the accounting and recordation of a transaction; it lacks clarity as to the appropriate treatment for ratemaking purposes. When an asset is retired at the end of its useful life, the book cost of the asset and the cost of removal are charged to the Accumulated Depreciation account, and the salvage value (e.g., proceeds from plant sales) is also credited to the Accumulated Depreciation account to offset the cost of plant and the cost of removal. Under normal retirement, the USOA prescribes the same treatment as if the plant serves out its full useful life. It makes ratepayers responsible for paying back the cost of plant investment and a return on the investment to the shareholders, together with any loss or gain from the retirement.

· In the case of abnormal retirement, e.g., the retirement of a building due to fire damage, the USOA will isolate the gain or loss resulting from the occurrence and will record it either in a Miscellaneous Credit or Debit account awaiting the Commission's decision for ratemaking purposes. The USOA only provides the accounting instructions and procedures to record the transaction; it does not provide or mandate any ratemaking guideline to the treatment of the gain or loss from the sales.

· Ownership interest by ratepayers in the property. Some commissions find that ratepayers pay only for the service while the shareholders maintain ownership interest in the capital. While shareholder ownership of the capital is not at question here, this begs the question of how the gain from sale of the capital should be allocated. Allocation of all or part of the gain to ratepayers does not interfere with the shareholders' claim to the capital itself.

· Intergenerational equity. A lack of intergenerational equity arises, for example, when benefits that accrue to current customers are paid by future customers. The theory is that the group of customers that realize the benefit should pay the cost associated with the benefit.

· This Commission has not found that intergenerational inequity is an appropriate criterion to consider in determining who should receive the gain on sale of a utility asset.

· Need for investment in infrastructure improvements. Some jurisdictions consider the gain as something to save for future investment in utility plant. Capital planning at this Commission is incorporated in general rate case reviews that scrutinize the utility's construction budget to ensure that sufficient investment is made to maintain quality service, meet anticipated demand increases, and to offer new services.

· Incentives for management to sell wisely and timely. The utility management has the obligation to use assets efficiently and to buy and sell assets prudently. This is to keep the prices for utility services as low as possible, while providing customers with good utility service.

· However, if the Commission provides "incentives" to a utility to manage assets efficiently that are higher than necessary, prices for service may also be unnecessarily high because the revenue requirement paid by customers does not reflect additional revenues that could be used to offset the cost of service. For instance, it is a goal of this Commission to encourage prudent investment in and continued ownership of property that is necessary for utility service, and to ensure that management disposes of properties that have been rendered unnecessary by change of circumstance, and to encourage utility management to negotiate a reasonably high sale price. This may require that shareholders be given an incentive of a small percentage of the gain even though other factors, such as the burden of the financial risk of the investment, suggest that ratepayers should receive the entire gain. Such an incentive would promote efficiency as it encourages utility management to stress the above goals. However, an increase in this percentage would lower efficiency, as a higher incentive would not be necessary to achieve these goals, it will transfer money needlessly from those who bore the risk burden of the investment, and it will encourage speculation by utility management.

· It is reasonable to provide shareholders with a guarantee of a small percentage of the gain upon sale of utility assets, a share that is great enough to provide an incentive for management to promote the above goals, but not so great as to interfere with the efficiency goals of the Commission or promote speculation by utility management.

· Utility management also has the requirement under PU Code 455.5 to advise the Commission whenever an asset has become no longer used and useful for utility service. This requirement will be discussed below.

· Obligation of utility to provide ongoing service. The first objective of the utility is to provide service to the ratepayers. It is responsible for maintaining the capital in such a way that it will continue to provide adequate service. Firms do not make capital utility investments to make a profit by realizing gain on the appreciation of the capital assets. Rather they are made with an objective to earn a return on the investment on an on going basis.

· The specific nature of the sale. This category is self-explanatory. Many of the state commissions' determinations of the allocation of the gain from sale were governed by the specific nature and circumstances of the sale.

· Opportunity cost for the utility. Some states have factored in opportunity cost for the allocation of gain on sale of asset. Opportunity cost is how much the utility would have earned had it invested the same capital elsewhere. Under the Commission's ratemaking practices, the rate of return allowed the utility is calculated by considering the opportunity cost of the capital invested in the company.

Some states will allocate the gain based on the proportion of time the asset has been in ratebase, while others will allocate the gain entirely to ratepayers if the asset has at any time been in ratebase. These states argue that if ratepayers have contributed to the cost of the asset, they should share in the gain.

More than half the states cited legal or commission precedent as having influenced commission policy on this issue.

Risk was the third most cited rationale, citing the CPUC's action regarding SoCal Gas' sale of its headquarters in A.87-04-041, D.90-11-031.

Delaware has taken guidance from a Federal Communications Commission (FCC) order (Docket No. 20188, 11-6-1980):

...Thus, the ratepayers bear the risk both in terms of the return they pay the investors for the use of their capital and in the reimbursement of the investors for the decline in value (depreciation) of the assets used to provide service.... Thus when such a piece of property is retired and disposed of and a gain results, the equities of the situation would suggest that the ratepayer should receive the benefit of that gain.

The Tennessee commission in #93-06946 said:

It is a well established principle, adopted by the Courts and this Commission, that gains as the result of the removal of utility assets from regulated service go to the interest of those who bore the risk over the regulated life of the assets.

Nineteen states said that ownership considerations are important, and several supported the doctrine that ratepayers pay for the use of the assets, but not the assets themselves.

Several cited the USOA, and used those accounting rules for the disposition of gains. However, these rules themselves do not give precise guidance regarding the ultimate disposition of the gains. There is a difference in how the FERC and FCC apply this system. Generally, the FERC policy is to allocate the gain to shareholders. The FCC policy allocates gains on the sale of land to ratepayers if the land was in ratebase.

Thirteen commissions cited whether the assets were depreciable as a rationale. The Missouri commission said in EO-85-185 and EO-85-224:

The argument for passing through the profit to the ratepayer is less persuasive in the case of nondepreciable property, since the shareholder has not received a multiple recovery of the investment through depreciation and again through a sale of the property.

Once again, most of the states do not have a rule that governs all situations, but decide the disposition of the gain on a case-by-case basis.

Parties may comment on whether gain-on-sale policies adopted by other states should form the basis of CPUC policy.