Duquesne Light Company v. Barasch – Oral Argument – November 07, 1988

Media for Duquesne Light Company v. Barasch

Audio Transcription for Opinion Announcement – January 11, 1989 in Duquesne Light Company v. Barasch

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William H. Rehnquist:

We’ll hear argument next in No. 87-1160, Duquesne Light Company v. David M. Barasch.

Mr. Buscemi, you may proceed whenever you’re ready.

Peter Buscemi:

Thank you, Mr. Chief Justice, and may it please the Court:

Duquesne Light Company and Pennsylvania Power Company are regulated public utilities in the State of Pennsylvania.

They are obliged by statute to provide adequate and reasonably continuous electrical service to their customers.

To fulfill their statutory duty to serve, Duquesne and Penn Power are required to anticipate and provide for future energy needs and demands.

During the 1970s, Duquesne and Penn Power spent $50 million in planning and preparing for the construction of four nuclear power plants.

The utilities decided to build these plants in response to extreme pressure from the Pennsylvania Public Utility Commission as well as regulatory authorities in neighboring states.

The Commission believed in 1973 when the decision to build was made that additional generating capacity was needed to meet expected demand.

Accordingly, Duquesne and Penn Power spent $50 million for, among other things, architectural and engineering services, surveying, construction planning, supplies, preparation of licensing applications and consulting fees.

In January 1980, as a result of unforeseen and unforeseeable changes of circumstances, Duquesne and Penn Power cancelled the four nuclear plants and did not proceed with the actual construction.

This case is here on appeal from the Supreme Court of Pennsylvania because the state has sought to deny Duquesne and Penn Power any opportunity at all to recover any portion whatever of the $50 million the utilities spent in planning for and preparing to build the four cancelled plants.

Sandra Day O’Connor:

Counsel, the Pennsylvania Supreme Court, I take it, remanded this case to the Pennsylvania Public Utilities Commission for further proceedings.

Peter Buscemi:

Yes, I think that’s correct, Justice O’Connor.

Sandra Day O’Connor:

Is it… is it possible that the Pennsylvania Public Utilities Commission could increase the risk premium portion of the equity rate to reflect the increased risk on remand?

Is there some way that your client could be compensated in a different way on remand?

Peter Buscemi:

Well, Your Honor, we’ve obviously thought about that, and I’d like to be able to say that the answer to your question is yes.

But I honestly think that under the decision of the Supreme Court of Pennsylvania and under its reading of the statute, Section 1315 of the Pennsylvania Public Utilities Code, we would not succeed in that effort on remand.

Indeed, I suspect that my adversary here, the Consumer Advocate, would say that that is just a way of accomplishing in one manner what cannot be accomplished in another, and that the Supreme Court of Pennsylvania has said on page 14a of the Appendix to the Jurisdictional Statement this shall not be done in any way whatsoever.

Sandra Day O’Connor:

Well, it wasn’t altogether clear to me, and it was not clear to me whether this then is a final judgment.

Peter Buscemi:

Well, Your Honor, I think that the–

Harry A. Blackmun:

That’s the real question at this point in my mind also, whether you have a final judgment here.

Peter Buscemi:

–I think we do have a final judgment, Your Honor, on the point of whether any portion of this $50 million of expenses will be recovered in any way whatsoever.

I can’t imagine the Supreme Court of Pennsylvania using stronger language than it has used in its opinion.

Antonin Scalia:

You… you’re not interested in recovering expenses.

You’re… you’re… you’re interested in getting enough money to run a… a profitable business whether it’s done by computing your expenses and then giving you enough over that to do so or whether it’s done in some other manner.

What do you care whether they allow you the return on this nuclear plant so long as you have a high enough rate of return?

Right?

Peter Buscemi:

Oh, I think that’s quite correct, Your Honor.

Antonin Scalia:

So, what if the state, in light of the fact that they have now exposed you to a… a greater risk than in the past… that is, you… you have to build these plants and you can’t get… get that thrown into your rate base unless they’re used and useful.

Antonin Scalia:

What if the state says in light of that added risk, we’re going to kick up your rate of return from 18 to 25 percent?

Would you have been harmed at all?

Peter Buscemi:

In theory I think the answer to that question is no.

But as the statute that’s at issue here, Section 1315 of the Pennsylvania Public Utilities Code, has been interpreted by the Supreme Court of Pennsylvania, that can’t happen because the statute, the critical statutory language, which appears on page 24L of the… of the Appendix says

“nor otherwise included in the rates charged. “

And that is precisely the language on which our opponents relied in the Supreme Court of Pennsylvania to say that there was absolutely nothing that could be done.

Antonin Scalia:

Well, the hypothetical I gave you does not include the cost of the plant in the rates charged at all.

It just gives you higher… higher return in light of the fact that you are now undergoing a higher risk.

That is the risk of not being able to get that included in… in your rate base if it turns out not to be used and useful.

Peter Buscemi:

Well, Your Honor, I think it’s inescapable that if you accept the proposition that you are suggesting, the $50 million, the prudent expenses that were incurred by Duquesne and Penn Power, would be in some way, whether you call it directly or indirectly, included in the rates charged because there would be a recovery of the sums that were expended.

And that’s–

Well, that’s–

Peter Buscemi:

–your hypothetical that you–

Antonin Scalia:

–That’s a very broad reading of that language.

Maybe… maybe it means that.

I wouldn’t… I wouldn’t take it to mean that automatically.

Peter Buscemi:

–Well, Your Honor, we’ve been confronted in this case with a very broad reading of the statutory language.

As you know, the Public Utility Commission of Pennsylvania granted 10-year amortization of the $50 million in expenses that are at issue here.

And that ruling, which appears in Appendices C and E of the Appendix, was sustained by the Commonwealth Court of Pennsylvania, both of whom interpreted the statute not to apply to a situation involving cancelled plants, but merely to be a timing measure with respect to the time of recovering the cost of construction work in progress.

Both the Commission and the Commonwealth Court said that the statute was only designed to make certain that the Commission understood that its pre-existing practice was not to be changed and that with respect to plants not yet on-line, construction work in progress was not to be included in rates in any way until such time as the plants went into service.

But both the Commission and the Commonwealth Court thought that the statute did not apply to the cancelled plant situation or to the plant taken out of service before the costs incurred in building that plant had been completely recovered.

Both of those things they said were not covered by the statute.

But our opponents disagreed and the Pennsylvania Supreme Court disagreed and said I believe in no uncertain terms that these expenses were simply out of the equation, not to be considered, not to be recovered, to be treated as if they had not been made.

And that is what brings us to this Court today because there are several key facts about this dispute… about this case that, I should say, are not disputed at all.

It’s common ground that the utilities’ decision to begin work on these four plants was a prudent one.

It’s also accepted that the $50 million of expenses were prudently incurred.

There’s no controversy about the amount of money that was actually spent.

Finally, everyone agrees that the decisions by the utilities in January 1980 to cancel the plants was prudent under all the circumstances then prevailing.

So, the fact of the matter is that at every step along the way, the utilities did just what prudent, well-managed utilities were supposed to do.

They behaved just the way the Commission wanted them to behave and they invested their capital not for some frivolous purpose, but for the purpose of providing the electric service to their customers that they must provide under Pennsylvania law.

Peter Buscemi:

These expenses that we’re arguing about today were not wasted in any real sense.

The money had to be spent to put the utilities in the position to go forward with construction if the conditions warranted it.

Sandra Day O’Connor:

Well, I think it’s… it’s clearly a frustration to the utility company under the scenario you paint, but under the Hope Gas case, don’t we look at the bottom line to whether the economic impact overall can be characterized as confiscatory?

And isn’t that the bottom line?

And how can we look at that bottom line until we know what happens on remand?

Peter Buscemi:

Your Honor, I think the one thing that we do know about what happens on remand–

Sandra Day O’Connor:

Is that the test under Hope Gas?

Peter Buscemi:

–Well, under Hope Gas, there’s no question that the–

Sandra Day O’Connor:

You look at the overall effect to see whether it’s confiscatory.

Peter Buscemi:

–The Supreme Court in that case used the phrase “end result”, a phrase that has been much used by our opponents.

And the rate order as a whole must be looked to to see whether it’s “confiscatory”.

Of course, that begs the question of what it means for a rate order to be confiscatory.

The first… Mr. Justice Harlan back in Smyth v. Ames said that the question of how you determine whether a rate order is confiscatory and the necessary elements in that inquiry will always be what he called an embarrassing question.

Well, it remains an embarrassing question today because it is not easy to know how one tells whether a rate order is or is not confiscatory.

In our view, this rate order is confiscatory within the meaning of Hope Natural Gas simply because $50 million worth of prudently incurred expenses, expenses incurred for the sole purpose of providing electric service, have been ignored, and on remand, they must continue to be ignored.

William H. Rehnquist:

But one could read Hope Natural Gas as saying that if… considering all of your clients’ investment in the utility business and if the… if the rate of return allowed on that investment, even after having subtracted this that you say should be included but won’t be, if that gives them a reasonable return, that’s good enough.

Peter Buscemi:

Your Honor, I agree that Hope can be read that way, but the simple fact of the matter is that the Pennsylvania Public Utility Commission, in setting the rate of return to be permitted on Duquesne and Penn Power’s debt, preferred stock and common equity, has done so in a way that does not take account of these expenses.

They have fixed a rate of return that they believe is a lowest reasonable rate of return wholly apart from these expenses.

So, we know on the basis of what has happened in this case that these expenses have not been taken into account in setting that rate of return.

William H. Rehnquist:

Well, you say then that it’s a matter of constitutional dimension.

Every time a public utility commission refuses to allow a particular item as… on which the utility claims return.

Peter Buscemi:

We’re saying, Your Honor, that there is a constitutional component of utility rate orders, absolutely, that expenses incurred for the purpose of providing electric service are… can rise to the level of a constitutional–

William H. Rehnquist:

Well, supposing here we were talking about an expenditure of $50,000 or some much lesser sum, and it was… it was much more debatable as to whether this sort of thing really should be included in the capital base, I take it your position would still be that if you could show that it should have been, then it’s a constitutional question.

Peter Buscemi:

–Well, first of all, in this… just to make sure that we have the facts right, there’s no question here about including this… these expenditures in rate base.

This is purely a question of recovery of expenses, cash operating expenses or other expenses that were used for electric service.

It’s not a question of the rate base on which your return should be earned, at least as the case comes to this Court today.

But, yes, Your Honor, I don’t think that the specific amount of the expense determines whether or not the Constitution does or does not apply.

It may have lots of other practical significance.

It may determine whether or not the utilities think the matter is sufficiently important to pursue, of course.

But as far as–

William H. Rehnquist:

What… what if the Utility Commission were to say we think a fair rate of return on Duquesne’s investment is 7 percent, but we’re going to disallow these expenditures for nuclear plants?

Let’s… and then it comes to this Court and we say, well, we don’t think they should have disallowed it, but we think a fair rate of return is 6 percent.

And so, Duquesne is still getting what it ought to under the Constitution.

Peter Buscemi:

–Well, I think in that… in that event, Your Honor, if the case were to come to the Court in that posture, I don’t think the Court would be likely to review the agency’s decision with respect to its conclusion on rate of return because that matter simply wouldn’t be before the Court–

What… what–

Peter Buscemi:

–as it’s not here.

William H. Rehnquist:

–What if… what if the Respondent cross-petition said we think the… that the agency is allowing more than the Constitution requires as a rate of return?

Peter Buscemi:

Well, as the… the Constitution, as this Court’s decisions in Natural Gas Pipeline and other cases make clear, does not fix a specific rate of return.

It says that a rate of return may not be confiscatory on the low end and it may not be so high as to completely overwhelm the consumers’ interest on the other hand so that there is a range.

And I think it’s generally accepted that public utility commissions, particularly in this era of increasing costs, have attempted to fix utility rates at the lowest reasonable rate, which is the minimum rate that the commission believes is necessary to satisfy constitutional standards.

So, I think that’s what’s… that’s what’s going on.

And I think that with respect to these costs, we’re not in the rate of return issue at all because here we’re only talking about the amortization of the $50 million in expenses, not the question of whether a return can be earned on the unamortized balance.

That has not been litigated in this case.

Anthony M. Kennedy:

But the Chief Justice’s point still remains that no matter how small the excluded amount, if it is excluded, you think there’s a constitutional issue.

Peter Buscemi:

Your Honor, I don’t think that anything turns under the Fifth and Fourteenth Amendments on the amount of property that has been taken.

I think very small takings of property can rise to a constitutional level in… in the proper circumstances.

Antonin Scalia:

Mr. Buscemi, it’s nice of you to not ask for it, but… but… but really, we shouldn’t kid ourselves.

If you’re right that you’re entitled to… to return of the capital, you’d also be entitled under the Constitution to interest on that capital while it’s invested, wouldn’t you?

Peter Buscemi:

Well, Your Honor, we come here this morning with two basic submissions.

The first is that the Constitution requires a consistent neutral adherence to one method of fixing rates.

Antonin Scalia:

Are you going to get to the answer to my question?

Peter Buscemi:

Yes, Your Honor.

And the reason that that’s relevant is because I think under that submission whether the public utility commission chooses the so-called prudent investment route or the… some version of the so-called fair value method, it should permit a return of prudent costs and a recovery… and a return on the unrecovered costs.

And I think that that is inescapable under any consistent method of regulating utility rates.

Antonin Scalia:

All right.

I… I just want to be sure you didn’t have some… different constitutional theory that it would somehow permit us to… to require the state to provide recovery of the investment, but not recovery on the investment as well.

Peter Buscemi:

Now, the second–

Antonin Scalia:

You don’t know of any in particular.

Peter Buscemi:

–Well, the second submission, which I was just about to describe, really follows the line that Justice O’Connor suggested a moment ago and relies on Hope Natural Gas and the end result principle.

Now, in Hope Natural Gas, it talks about balancing investor and consumer interests.

Peter Buscemi:

It provides very little guidance for how that balancing is to be done.

It doesn’t address the question that I mentioned in our first submission, namely, that there should be a consistent, neutral method of ratemaking.

It simply says balance and look at the end result.

Well, if… if that’s all that the Constitution tells us, if that’s the entirety of it, which we don’t think it is, but assuming it is, and if all you have is that injunction in Hope to balance, then our submission is in this case that balancing didn’t occur because the $50 million in expenses were simply removed from the equation.

There was no opportunity for anybody to balance them.

Indeed, we know what happened when the Commission did balance them.

The Commission balanced… the administrative law judge who first looked at this balanced, and he said in Appendix H of the… to the Jurisdictional Statement I think on balance, when I balance the investor and consumer interests, you ought to get your money back over a 10-year period, obviously, already less than the current value of the money or the value of the money when it was invested.

I think you ought to amortize your investment over a 10-year period and get it back, but I don’t think you ought to get any return on the unamortized balance.

That’s what he said, and the Commission approved that when they did the balancing.

William H. Rehnquist:

Then the legislature disapproved it.

Peter Buscemi:

Well, the Supreme Court of Pennsylvania, in interpreting a statute that was enacted by the legislature between the time of the administrative law judge’s decision and the time of the Public Utility Commission’s decision, decided that the legislature had meant not to permit this sort of thing.

William H. Rehnquist:

Why should we favor the… what you call the Commission’s balancing over the legislature’s balancing?

Peter Buscemi:

Well, Your Honor, I think it’s doubtful whether the legislature did any balancing here at all.

That’s why we are challenging this statute because we think that the–

William H. Rehnquist:

How does one know whether the legislature did any balancing or not?

Peter Buscemi:

–Well, I think when you look at the statute, Your Honor, it simply says that this sort of expense… that is, expense incurred in building an electric generating plant… may not be included in the rates charged in any way until the plant is in service.

Now, when that’s applied to a cancelled plant as in… in this case, it means that there is no balancing.

It means that there’s–

William H. Rehnquist:

What if the Commission had said after thinking this over for a long time and considering the interests of the consumers and the utility and balancing things as best we can, we conclude, and then they say exactly what the legislature said?

Peter Buscemi:

–Well, Your Honor, the fact is that that… the legislature was not doing that.

I mean, the legislature was not looking at the rate order of Duquesne Light Company and Pennsylvania Power Company, the tariffs that were filed by those companies, and reviewing them.

That’s not what the legislature was doing or purported to be doing.

William H. Rehnquist:

Well, do you think the legislature can’t pass a general statute applicable to all utilities such as this?

Peter Buscemi:

Your Honor, all we’re saying is that under the second submission that I was making with regard to the Hope Natural Gas balancing test that if all the Constitution requires is that everything be balanced in one proceeding, then that’s not what happened here.

It didn’t happen here because the Pennsylvania legislature removed one important item from the balance, namely, these expenditures.

And that’s what we don’t think Hope permits it to do.

William H. Rehnquist:

Well, you say then a legislature has to leave up to its utility commission, which is presumably almost an agency of the legislature… it has to leave to the utility decision… commission all decisions as to how each of these factors is to be brought in.

It can’t pass a general legislation that would bind the commission.

We’re saying in our second submission with… under Hope that the entity, whether it be the legislature or the rate… or the public utility commission that sets the rates, must have the right to take everything into account which we think is what Hope says.

But I return to what I said in response to Justice Scalia’s question, which is that our first submission is that under Hope, under Natural Gas Pipeline, under the earlier decisions of this Court as well, there has never been a suggestion by the Court that a ratemaking body, whether it be a state legislature or a public utility commission, can pick and choose among ratemaking methods so that it produces the result that it wants to achieve.

William H. Rehnquist:

This is a case in which the Public Utility Commission follows, generally speaking, the original cost-prudent investment method of fixing rates.

But when it comes to cancelled plants, as in this case, suddenly we have a situation in which the used and useful rule is injected into the equation and the $50 million worth of expenses are deleted altogether from the balance.

Mr. Buscemi, is that… is that where the… where the balancing that Hope referred to occurs?

At each individualized decision, will this be included in the rate base, will that be included in the rate base?

It seems to me that the balancing occurs at the moment of truth, when the state agency, whatever state agency it is, determines how much money is this utility entitled to get from the ratepayers.

And when that judgment occurs, you can balance.

For all we know, when that judgment comes before the utility commission, the commission will say, well, gee, now that we have this used and useful rule, the stock of these utilities are going to be a lot less attractive.

We’re going to have to give a higher… a higher return on equity.

Therefore, whatever the rate base is, we’re going to have to apply a higher… a higher rate of return to it.

Now, how do we know that that balancing isn’t going to occur at that stage?

Peter Buscemi:

Well, with all respect, Your Honor, I think we know it because the Pennsylvania Supreme Court has told us that it will not occur and it may not occur under the State law of Pennsylvania.

Antonin Scalia:

You come back to that language that this… there can be no return on this–

Peter Buscemi:

Your Honor–

Antonin Scalia:

–Is that the language you’re referring to?

What page was it again?

Peter Buscemi:

–Well, there are… there… the statutory language appears on page 24L, and the language of the Pennsylvania Supreme Court in interpreting it appears on page 14a.

The Pennsylvania Supreme Court says Section 1315

“clearly conveys but one meaning: that the cost of uncompleted projects shall not only be excluded from the rate base, but shall not, in any way whatsoever, be included in the rates charged. “

Well, the only way that the utility obtains revenue is in the rates that it charges, and the rates that it charges must be the rates approved by the Public Utility Commission.

Antonin Scalia:

But what I’m saying will get reflected in the rates charged is not this particular capital expenditure, but rather the increased… the increased profits that equity investors are going to demand in order to invest in what is now a higher risk enterprise.

I don’t see how that bears any relationship to charging the ratepayers for these particular plants.

Peter Buscemi:

Well, Your Honor–

Antonin Scalia:

They’re charging the ratepayers for a higher risk and therefore necessity to pay higher return.

Peter Buscemi:

–Your Honor, I wish I could say that I share your confidence in what the Pennsylvania Public Utility Commission–

Antonin Scalia:

xxx say I had a whole lot of confidence.

I just said that maybe you have to come back at some other time and show us that you’re not getting enough of a rate of return.

Peter Buscemi:

–Well, I think the Supreme Court of Pennsylvania in its decision interpreting this statute has directed the Public Utility Commission not to build these expenses in in any way, shape or form, not to build them in in a higher rate of return, not to build them in through amortization, not to consider them, to act as if they hadn’t been spent.

Anthony M. Kennedy:

But is it… has it foreclosed a higher rate of return than you’re getting now?

Peter Buscemi:

Excuse me, Your Honor?

Anthony M. Kennedy:

Does anything in the opinion foreclose a higher rate of return than you are getting now?

Peter Buscemi:

If it’s based on… on these expenditures in any way–

Anthony M. Kennedy:

No.

Peter Buscemi:

–I think it does.

Anthony M. Kennedy:

As an absolute matter, does it foreclose your getting a higher rate of return than you’re getting now?

Peter Buscemi:

The issue of the rate of return was not addressed in the opinion, Your Honor.

It was not part of what the Consumer Advocate appealed.

The Consumer Advocate didn’t appeal anything about rate of return.

The Consumer Advocate appealed the recovery of $50 million in expenses through amortization as an expense wholly apart from rate of return.

Rate of return is calculated on the rate base, and these expenses were never included in the rate base.

John Paul Stevens:

May I ask you?

It might oversimplify.

You’re claiming I gather there’s a constitutional right to recover all prudently incurred expenses.

Peter Buscemi:

Well, Your Honor, I didn’t say that although I think–

John Paul Stevens:

But doesn’t it boil down to that?

Peter Buscemi:

–Well, I think that that would be an acceptable way of resolving this case.

John Paul Stevens:

Well, does… does your contention boil down to that?

Peter Buscemi:

No, Your Honor.

I think we say that there must be a consistent, neutral way of doing–

John Paul Stevens:

But… and that it’s not consistent if you exclude a category of prudently incurred costs.

Peter Buscemi:

–If you… if with respect to the remainder of the investment you proceed on the prudent investment basis, yes.

If the Public Utility Commission, as it has in Pennsylvania, decides to use an original cost-prudent investment method for determining what’s included in the rate base and how to calculate rate of return–

John Paul Stevens:

Then it must include all prudently incurred–

Peter Buscemi:

–They should do it across the board and not–

John Paul Stevens:

–No, not they should.

The Constitution compels them to.

Peter Buscemi:

–Yes, Your Honor.

John Paul Stevens:

Which would mean under that view that the issue of whether these costs were prudently incurred, if that were to be debated, would be a federal constitutional issue.

Peter Buscemi:

Well, I think it… it could rise to that level yes.

But–

John Paul Stevens:

Well, it would in every case.

John Paul Stevens:

It would in every case it seems to me.

I don’t understand how… unless you just say it has got to be at least $50 million.

Peter Buscemi:

–No, no.

It does not depend on the amount of the expenses.

I don’t turn from that at all.

John Paul Stevens:

And… and the issue would be the same if it… here, of course, it’s stipulated they’re prudent.

But, you know, other cases it might not be.

Peter Buscemi:

Well, that’s true, Your Honor.

I can’t deny that.

There’s no question that in other cases the issue of prudence may be debated.

It’s not here.

I’d like to reserve the remainder of my time please.

Thank you.

William H. Rehnquist:

Thank you, Mr. Buscemi.

We’ll hear now from you, Mr. Popowsky.

Irwin A. Popowsky:

Mr. Chief Justice, and may it please the Court:

In our view, the question presented in this appeal is a narrow one.

That question is whether a public utility has a constitutional right to charge ratepayers for the cost of any particular investment even where the denial of recovery of that investment is not alleged to have any significant impact on the utility’s overall rate level or financial condition.

Our proposed response to that question and the framework for my argument today is twofold.

First, and most importantly, I will argue that the Court should simply reaffirm the Hope Natural Gas decision and thereby reject the utilities’ appeal in this case.

Hope and the decisions of this Court which followed it have made it clear that the proper focus of this Court’s review is on the overall end result of the rate order not upon the individual components of that order and not upon the methods used to arrive at that result.

Sandra Day O’Connor:

Mr. Popowsky, what is open to the Utility Commission on remand to do in terms of adjusting the rate of return?

Irwin A. Popowsky:

Your Honor, as you pointed out, this case has not been… this case has been remanded to the Public Utility Commission.

Right.

Irwin A. Popowsky:

The company… we do not yet know what arguments the company will make.

Sandra Day O’Connor:

Oh, in your view can the Utilities Commission on remand adjust the rate to take into account the fact that prudent investors apparently now are not going to be allowed any… even recovery of the costs of prudent investments?

Irwin A. Popowsky:

The company would be–

Sandra Day O’Connor:

Can the Utilities Commission adjust the rate–

Irwin A. Popowsky:

–The company would be–

Sandra Day O’Connor:

–to account for that risk?

Irwin A. Popowsky:

–The company would be free to make that argument.

However, I would point out that what the Pennsylvania Supreme Court held–

Sandra Day O’Connor:

I’m not asking what the company can argue.

I’m asking in your view what the Commission can do.

Irwin A. Popowsky:

–Your Honor, if the Commission finds that the risk of investment… and I’m talking about the risk of investment rather than the costs of these investments… is increased, then in our view the Commission is free to raise the rate of return on the company’s overall investment.

What I was going to suggest, Your Honor, is that the more appropriate course would be the one which I believe was indicated in Justice Scalia’s question which is what occurred in the State of Ohio; that is, if as a result of this alleged change in the Pennsylvania regulatory system… and we would contend there has been no change.

We would contend that the used and useful principle as held by the Pennsylvania Supreme Court has long been in effect long before this statute occurred.

But if there has been an increase in the company’s overall risk, then the company is certainly free… and they have been free for the last several months at least… to seek a rate increase in which they would allege that the rate of return that has been allowed by the Commission is inadequate to meet their capital needs.

And that, Your Honor, is the difference between the risk of loss… I’m sorry… between compensation for the loss on these particular investments and compensation for risk.

Our argument–

Anthony M. Kennedy:

If the Commission does not do that, has the company… and the company comes back to the Pennsylvania Supreme Court and perhaps ultimately to this Court… has the company preserved all of the arguments that it’s making now in your view?

Irwin A. Popowsky:

–I believe the company on remand has preserved these issues.

Anthony M. Kennedy:

If we say that this order is not final or not reviewable or that there’s no Hope violation at this point, can the company come back after their rate order is made and make all of the arguments that it’s making here today?

Irwin A. Popowsky:

I believe so, Your Honor.

And the point is… and I think you’re correct… that… that the Hope decision… if the company had made a proper claim under Hope, if the company had claimed that the overall end result of this rate order was confiscatory, then I would argue that the company’s arguments are premature.

We can’t possibly know what the final end result of this case will be because it’s not over.

However, the company did not make that argument.

And what we’re suggesting that the company’s not only… argument is not merely premature, it is simply wrong.

The company is contending that they have a… a constitutional right to recovery of this particular investment.

And we suggest that under the Hope Natural Gas case it is absolutely clear that it is the… it is only if the end result of the rate order is… is confiscatory that such a result can be reached.

Byron R. White:

Well, that… that… to that extent, the judgment is surely final, isn’t it?

Irwin A. Popowsky:

To the extent that the Supreme Court of Pennsylvania has ruled that these particular expenses may not be included in the rates, yes, the judgment is final.

Byron R. White:

No matter what the… no matter… if the… if the Commission takes some action that reflects those costs, it’s… it’s wrong.

Irwin A. Popowsky:

If they take an action that reflects the costs, Your Honor, and rates–

Byron R. White:

Those specific costs.

Irwin A. Popowsky:

–But if the Commission is free to take action that reflects the risk of non-recovery of costs.

And for that matter, the Commission can and does reflect all risks that are… that face the utility when it sets the–

Byron R. White:

The rate.

Irwin A. Popowsky:

–the rate of return in every rate case.

And I believe that is what the–

Byron R. White:

Just the rate.

Just the rate, not the base.

Irwin A. Popowsky:

–The rate of return which is applied to the rate base.

Byron R. White:

Yes.

Irwin A. Popowsky:

That’s right, Your Honor.

William H. Rehnquist:

Do you think under Hope Natural Gas a utility commission could say to Duquesne… the Pennsylvania Utility Commission here… this has been a bad year for consumers and we know you’ve prudently spent a million dollars in working some of your plants, but we’re just not going to allow that to you this year because the consumers can’t afford it?

And so, you take… you claim it as a constitutional violation.

And the Commission says, well, look, their overall base is… figuring on the rate of return is perfectly okay.

The fact that there are these individual disallowances doesn’t make any difference even if they’re for totally unacceptable reasons.

Irwin A. Popowsky:

Well, Your Honor, the… the… the threshold examination in… under Hope… and as… is that the end result of the rate order must satisfy the investor interests in Hope.

If those investor interests are satisfied, then the rates are just and reasonable and there is no constitutional violation.

William H. Rehnquist:

No matter how bizarre some of the reasoning of the Commission may be as to why it was disallowing expenses or items in the rate… rate base?

Irwin A. Popowsky:

Your Honor, there would be no confiscation under that case under Hope.

However, the utility, as well as the ratepayers, have other protections under the Constitution under the Due Process Clause.

The ratemaking methodology cannot be totally arbitrary.

William H. Rehnquist:

Would you say that would open to review a claim by the utility here that the Commission had been arbitrary in switching from prudently invested to use… used and useful?

Irwin A. Popowsky:

No, because that’s precisely the type of ratemaking methodologies that are within the range of methodologies that have… that have consistently been used.

And Hope states that it is the… in reviewing a rate order, it is the result reached not the methodology employed.

William H. Rehnquist:

Well, what… what if the utility could show that in every case where it benefited the consumer the state… the Commission had adopted one method and in… and in every case where it might have benefited the utility that it adopted another so that… you know, it ruled against the utility on every single claim it made whether it was used or useful or prudently invested?

Irwin A. Popowsky:

Under the… under the Hope standard and under the… the takings jurisprudence of this Court, I believe that there would not be a taking unless there was an overall end result that produced an unjust and unreasonable result.

As the Court held–

Antonin Scalia:

The Chief Justice isn’t talking taking.

He’s talking due process.

Irwin A. Popowsky:

–Oh, Your Honor, under the Due Process Clause under procedural due process and under… for example, under the… the Nebbia decision, if the method used is… is irrational or unrelated to any valid public purpose, then I would agree that there could be a… a due process violation.

It’s my understanding that the company here is claiming that there is… that this particular rate order is confiscatory.

And we are suggesting that as the Court held in FERC v. Pennzoil and in… in the Texaco case, which were both written by Justice White, that all that is protected against in a constitutional sense is that the rates be set at a level which is higher than confiscatory.

That’s as to the confiscation–

Antonin Scalia:

Wouldn’t you argue that even under the Due Process Clause you wouldn’t have to show a taking, but you’d still have to show a deprivation of… of property which would get you back ultimately to the same kind of inquiries we’ve been going through, wouldn’t it?

Wouldn’t it ultimately get you back to what… what is the overall rate of return even under the Due Process Clause?

Irwin A. Popowsky:

–Well, we would argue… it’s correct, Your Honor, that at least under Hope and under the cases that have followed it, that what is constitutionally relevant in a rate case, as opposed to perhaps a… a physical taking of a company’s property… what’s constitutionally relevant in a rate case is the overall rate level and that is the investors’ interest in ensuring that the utility can operate successfully and attract necessary capital.

Anthony M. Kennedy:

Is that wholly consistent with… is that wholly consistent with everything that Pennsylvania’s Supreme Court said?

Irwin A. Popowsky:

I think that what the Supreme Court did is consistent, yes, with the… with the overall end result; that is, at least there has been no allegation.

Our point here, Your Honor, is that there has been no allegation even as of today that the rate order in this case will have any material adverse impact–

Anthony M. Kennedy:

Well, I… I was talking about the Pennsylvania Supreme Court decision.

That made it very clear that the constitutional guarantee was limited to a fair return on property that is being used.

Wasn’t that the whole theory of the Pennsylvania Supreme Court decision?

And they say so specifically at page 21a of the Appendix.

Irwin A. Popowsky:

–It’s correct, Your Honor.

If you recall, that… that case was originally an appeal brought by the Consumer Advocate’s Office under… under statutory grounds.

The Consumer Advocate argued that the… the allowance was unlawful under state law grounds.

The companies came back and argued, no, we have a constitutional right to recover these prudently incurred expenses.

And it’s correct.

The… the Pennsylvania Supreme Court responded, no, you don’t have that right per se.

And the Pennsylvania Supreme Court based that on the fact that, in fact, these… these projects were not used and useful.

Anthony M. Kennedy:

But… but that’s not consistent with Hope, is it?

Irwin A. Popowsky:

Well, Your Honor, in… in that case the Pennsylvania Supreme Court also cited prior decisions of the… of that court, including the Pennsylvania Electric case which came to this Court and was dismissed.

In that case the court did address the Hope issue.

That was a case involving the… the Three Mile Island incident and whether a utility could recover the costs of the Three Mile Island plant.

And in that case the Pennsylvania Supreme Court did address the relative constitutional importance of the Hope investor interests versus the used and useful test.

Anthony M. Kennedy:

So, they were correct in the cases they cited, but not correct in what they said?

Irwin A. Popowsky:

No, Your Honor, I think they correctly responded to the company’s argument that was presented to them.

The company did not present the argument.

That is, in the Three Mile Island case, the company clearly presented the… the Hope end result test and suggested that the Commission order in that case violated that test.

In this case the companies argued essentially that they have a… as they’ve argued here is that their right rests in that individual item of property and the court responded, no, to the extent that you’re arguing that you have a right to recover the cost of this property, that is incorrect.

Anthony M. Kennedy:

Well, but it seems to me the Pennsylvania court does more than just respond to an argument.

It adopts a constitutional theory that just compensation is a reasonable return on fair value of the property at the time that it’s being used.

And that itself is the kind of formulation that we eschewed in Hope it seems to me.

Irwin A. Popowsky:

Your Honor, I would agree that they… perhaps the court didn’t need to reach that issue if they had addressed the… the Hope issue first; that is, the Hope, in essence, creates a two part examination.

First, it is necessary to determine that the overall end result of the order violates the investor interest.

That’s only the first part of the test in Hope.

Irwin A. Popowsky:

Second, one must consider whether the violation or failure to satisfy those interests is overcome by some countervailing public and ratepayer concerns.

Now, the used and useful principle has traditionally been used as one of those ratepayer concerns, and in certain cases it may, in fact, outweigh the investor interests identified in Hope.

So, what I would suggest, Your Honor, is that that is an issue that this Court need not reach because in this case, in coming to this Court, the company has failed to make the necessary threshold argument under Hope, that is, that the disallowance in this case has a–

Antonin Scalia:

Mr. Popowsky, would you–

Irwin A. Popowsky:

–[inaudible] effect on the overall rates.

Antonin Scalia:

–Would you agree if… if the state has, in fact… and I agree you claim it hasn’t, but if it has, in fact, changed from a prudent investment criterion of what goes into the rate base to a used and useful criterion, that the utilities would be entitled to a higher rate of return than what they had under the old system?

Would you concede that because if you would concede that, then I think… then I think maybe Mr. Buscemi has nothing to worry about.

[Laughter]

Irwin A. Popowsky:

Your Honor, I would concede that… that the proper rate of return established for a public utility in Pennsylvania should reflect all risks that that utility incurs.

If at time period A–

Antonin Scalia:

Well, this is a greater risk, isn’t it?

Irwin A. Popowsky:

–Yes, yes.

If at time period A, the company is operating under a system, which I don’t believe ever existed in Pennsylvania… and our Pennsylvania Supreme Court has so held, but if they operated under a system where all costs that the company spent could be included in rates, no matter whether they happen to produce electricity or not, if that was such a system and people invested under that belief, and then the law was changed, then prospectively… prospectively you would have to compensate or you should compensate investors for that… for that higher risk.

Antonin Scalia:

Your answer is yes I think.

Irwin A. Popowsky:

Yes.

Yes, it is.

Anthony M. Kennedy:

Would it make any difference if the… if the company had been ordered by the State Commission to make these investments?

Irwin A. Popowsky:

Your Honor, in the… in the… certainly in the second part of the Hope analysis… that is, in determining the relative balance of investor and consumer interests… it would… the nature of the government action would become important and to the extent that by, for example, ordering a utility to build a particular plant and particularly if the Commission also indicated at that time that we were operating under a… a regulatory regime under which all of those costs would necessarily be included in rates, then that company would have a stronger claim.

But the basic structure of the… of the Hope test–

Anthony M. Kennedy:

Well, would it have a claim that would win in this case or not?

Irwin A. Popowsky:

–Your Honor, initially one would… the Court should still examine in our view the… the Hope end result test or as was held in the FERC v. Pennzoil case, all–

Anthony M. Kennedy:

Even though the company may have opposed making this expenditure at all.

Irwin A. Popowsky:

–Your Honor, in that case, it’s quite possible that there could be some other protection to the utility.

For example, it sounds as if there was almost a contract at that point between the… the state and the company.

We’re very far from that in this case.

What we have is basically a passive set of regulation where the utility decides what to build and when to build and what to cancel and when to cancel.

And the role of the Commission is to… is to determine what is a just and reasonable rate.

If the rates are just and reasonable–

Anthony M. Kennedy:

So, the extent to which the Commission participated in this initial decision really isn’t tantamount to an order to build.

Irwin A. Popowsky:

–Certainly not in this case, Your Honor.

Irwin A. Popowsky:

It was not an order to build.

The utility was free to… to take any steps that it… that it chose to… to meet its… its future needs.

The genius of the Hope decision in our view is that it recognized what is truly at stake and therefore what is constitutionally protected in a utility rate case.

Hope recognized that investors have a legitimate interest in an overall rate level which permits the utility to operate successfully and to attract necessary capital.

But investors have no constitutionally protected interest in whether a particular cost item enters into the ratemaking equation, nor do they have a constitutionally protected interest in the application of any particular ratemaking methodology.

It also makes no difference from a constitutional perspective whether a particular rate claim involves the return on an investment or the recovery of that investment.

All that is protected against in a constitutional sense is that the rates fixed by the commission be higher than a confiscatory level.

Hope held that if the overall rate level cannot be said to be unjust and unreasonable, then investors have no right to complain and judicial review by this Court is at an end.

Unless this Court is prepared to overrule Hope, then I would submit that the companies’ appeal in this case is at an end as well.

But even if the Court were to accept the companies’ invitation–

Antonin Scalia:

What… what are you urging that we do with this appeal?

We… we should… should we decide the case and… and find in your favor, or is your argument that… that it’s not ready to be decided?

Irwin A. Popowsky:

–Your Honor, I… I think that you should decide in our favor the issues raised by the utility.

And the case has been remanded already, Your Honor.

The case was remanded by the Pennsylvania Supreme Court to the Pennsylvania Public Utility Commission.

What we’re saying is that this order should be affirmed and that the companies’ appeal does not… has not raised a valid Hope issue, and to the extent that it has attacked a specific item in the ratemaking equation, that is an improper appeal and should be rejected.

To the extent that they challenge Section 1315 of the Public Utility Code on its face, which I believe they’re doing, that should be rejected.

There’s nothing facially invalid about a… about a rule which restricts utility rate… specific rate recovery to individual assets.

Harry A. Blackmun:

Well, specifically do you feel there is a final judgment below?

Irwin A. Popowsky:

Yes, Your Honor, to the extent that the company has challenged specific aspects of that… of that judgment.

The only thing that I don’t think is final… what I’m trying to suggest is… going back to Your Honor and Justice O’Connor’s original questions, if this case in our view had raised the proper issue… that is, whether the overall end result was unjust and unreasonable… then in our view the case would… that appeal would be… would be premature in a sense because we don’t know what the final end result is.

To the extent that the case challenges Section 1315 of the Pennsylvania Public Utility Code on its face, that challenge should be rejected.

And to the extent that it argues that any individual item in any rate case must be specifically reflected in rates, we would ask that that be rejected as well.

Harry A. Blackmun:

Well, if you can take a position that this is not a final judgment, you’re home free, aren’t you, for the moment?

Irwin A. Popowsky:

For now, Your Honor.

Certainly we don’t think that the… that the State Supreme Court has done thing which… which warrants reversal of this decision.

Harry A. Blackmun:

Well, you certainly don’t argue it very strenuously in your briefs.

Irwin A. Popowsky:

Duquesne and Penn Power investors were never told by the state that they would be guaranteed recovery of investments which provide no service to ratepayers.

The Pennsylvania Supreme Court ruled in this case that the used and useful principle was established as a matter of state law… a matter of state ratemaking policy long before the enactment of the specific ratemaking provision at issue here.

Neither before nor after Hope, has this Court ever ruled that a utility has a constitutional right to charge ratepayers either a return on or a recovery of non-used and useful investment.

Irwin A. Popowsky:

There is, therefore, no basis upon which the utilities can now claim that their investors were unaware that there was at least a risk that non-used and useful investments would continue to be excluded from the ratemaking equation.

The companies’ argument would turn nearly every rate disallowance in every rate order into a constitutional issue.

The acceptance of the companies’ argument would return this Court and all reviewing courts to the pre-Hope era where generous rate increases to financially sound utilities could be attacked as confiscatory because of the failure to approve a specific cost item in a constitutionally proscribed manner.

The states would be unable to apply any other economic or policy considerations in determining how to set just and reasonable rates.

The companies’ argument also fails to recognize that ratemaking is an ongoing, dynamic process.

Duquesne Light Company has had five base rate cases just during the pendency of the appeals in this case.

In upholding the Federal Power Commission’s order in the Hope case, the court recognized that this is not an order for all time and that the doors of the Commission are open for increased allowances that prove to be necessary.

Rather than assigning constitutional status to every dollar of every rate claim of every public utility in the United States, we would respectfully ask the Court to reaffirm the Hope decision and deny the companies’ appeal in this case.

William H. Rehnquist:

Thank you, Mr. Popowsky.

Mr. Buscemi, you have two minutes left.

Peter Buscemi:

Thank you, Mr. Chief Justice.

My adversary has concentrated a lot on a individual item and says that our claim is a claim for an individual item of investment.

Our claim is a claim for a constitutional method of setting rates.

If Pennsylvania… and my opponent has not denied it… fixes rates of return based on prudent investment and a reasonable rate of return, the lowest reasonable rate based on the original cost-prudent investment method, which is what Pennsylvania does under Section 1311 of the Public Utility Code, then Pennsylvania must under the Constitution under the Fifth and the Fourteenth Amendments permit the recovery of prudent expenses incurred for the provision of electric service.

If Pennsylvania follows the fair value method, which is what the Pennsylvania Supreme Court suggests, Justice Kennedy, on page 21a of the opinion, but which seems to fly in the face of what the Commission actually does and what Section 1311 says, then the value of the used and useful plants and the rate of return on those plants can be adjusted to take into account expenses prudently incurred but not producing electricity.

That is not what happens in Pennsylvania.

That’s not what happened in this case, and that’s why we’re here complaining because the $50 million that Penn Power and Duquesne Light spent will never be recovered.

We will never be able to recover on a Mustang the losses that we’ve incurred on an Edsel.

That is the problem that we are bringing to the Court’s attention because the Pennsylvania Supreme Court has specifically ruled that Section 1315 precludes that kind of counterbalancing that normally would occur under the fair value regime that was originally envisioned by this Court in Smyth v. Ames.

That’s not what Pennsylvania does.

If the $50 million… and you did not hear my opponent say that the rate of return could be increased to take account of these costs.

That’s contrary to his position, and it’s contrary to the position that he would espouse on remand.

Thank you.

William H. Rehnquist:

Thank you, Mr. Buscemi.

The case is submitted.