Residential Utility Consumer Office v. Arizona Corporation commission/arizona Water Company , 240 Ariz. 108 ( 2016 )


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  •                                  IN THE
    SUPREME COURT OF THE STATE OF ARIZONA
    RESIDENTIAL UTILITY CONSUMER OFFICE, AN AGENCY OF THE STATE OF
    ARIZONA,
    Appellant.
    v.
    THE ARIZONA CORPORATION COMMISSION,
    Appellee,
    ARIZONA WATER COMPANY,
    Intervenor.
    No. CV 15-0281-PR
    Filed August 8, 2016
    Arizona Corporation Commission
    Nos. W-01445A-11-0310
    W-01445A-12-0348
    AFFIRMED
    Opinion of the Court of Appeals, Division One
    
    238 Ariz. 8
    , 
    355 P.3d 610
    (App. 2015)
    VACATED
    COUNSEL:
    Steven A. Hirsch (argued), Rodney W. Ott, Quarles & Brady, LLP, Phoenix,
    Attorneys for Intervenor Arizona Water Company
    Wesley C. Van Cleve (argued), Janet Wagner, Maureen A. Scott, Arizona
    Corporation Commission, Phoenix, Attorneys for Arizona Corporation
    Commission
    Scott S. Wakefield, Hienton & Curry, P.L.L.C., Phoenix; and Daniel
    Pozefsky (argued), Residential Utility Consumer Office, Phoenix, Attorneys
    for Residential Utility Consumer Office
    Christina Estes-Werther, General Counsel, League of Arizona Cities and
    Towns, Phoenix, Attorney for Amicus Curiae the League of Arizona Cities
    and Towns
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    John J. Egbert, Kenneth C. Sundlof, Jr., Jennings, Strouss & Salmon, P.L.C.,
    Attorneys for Amicus Curiae Southwest Gas Corporation
    Thomas A. Loquvam, Arizona Public Service Company, Phoenix; and
    Matthew E. Price, William K. Dreher, Jenner & Block LLP, Washington,
    D.C., Attorneys for Amicus Curiae Arizona Public Service Company
    Thomas H. Campbell, Michael T. Hallam, Lewis Roca Rothgerber Christie
    LLP, Phoenix, Attorneys for Amicus Curiae EPCOR Arizona, et al.
    Timothy M. Hogan, Joy Herr-Cardillo, Arizona Center for Law in the Public
    Interest, Phoenix, Attorneys for Amicus Curiae Arizona Center for Law in
    the Public Interest
    Michael W. Patten, Timothy J. Sabo, Snell & Wilmer L.L.P., Phoenix; and
    Bradley S. Carroll, Tucson Electric Power Company, Tucson, Attorneys for
    Amicus Curiae Tucson Electric Power Company, et al.
    Court S. Rich, Loren R. Ungar, Evan Bolick, Rose Law Group, PC,
    Scottsdale, Attorneys for Amicus Curiae Energy Freedom Coalition of
    America
    Timothy Berg, Theresa Dwyer-Federhar, Fennemore Craig, P.C., Phoenix,
    Attorneys for Amicus Curiae Water Utilities Association of Arizona
    Meghan H. Grabel, Osborn Maledon, Phoenix, Attorneys for Amicus
    Curiae Arizona Investment Council
    Jennifer A. Cranston, Gallagher & Kennedy, P.A., Phoenix, Attorneys for
    Amicus Curiae Grand Canyon State Electric Cooperative Association Inc.
    Timothy J. Sabo, Snell & Wilmer L.L.P., Phoenix, Attorney for Amicus
    Curiae Global Water Resources, Inc.
    Julie Nepveu, AARP Foundation Litigation, Washington, DC; and Veronika
    Fabian, Choi & Fabian, PLC, Chandler, Attorneys for Amicus Curiae AARP
    2
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    JUSTICE BRUTINEL authored the opinion of the Court, in which CHIEF
    JUSTICE BALES, VICE CHIEF JUSTICE PELANDER, JUSTICE TIMMER,
    and JUDGE STARING * joined.
    JUSTICE BRUTINEL, opinion of the Court:
    ¶1             The Arizona Corporation Commission (“Commission”)
    determines the rates that a public service corporation (a “utility”) may
    charge. The Arizona Constitution requires the Commission to determine
    the fair value of a utility’s in-state property when setting rates, which
    historically has occurred in a full rate case. During a full rate case, the
    Commission scrutinizes a utility’s financial picture and holds many
    hearings—often extending more than a year. Here the Commission
    approved a rate increase mechanism known as the system improvements
    benefit (“SIB”), allowing it to adjust rates between full rate cases to help a
    utility recoup the cost of newly-completed infrastructure projects. We hold
    that the SIB mechanism complies with the Arizona Constitution’s mandate
    that the Commission determine the fair value of a utility’s property when
    setting rates.
    I.    BACKGROUND
    A. Procedural history
    ¶2            Arizona Water Company (“AWC”) is a private, for-profit
    monopoly utility company that provides water service to several towns and
    rural communities. AWC is currently undertaking extensive capital
    improvements to its aging pipeline infrastructure. In 2011, AWC filed a rate
    case with the Commission for its eastern group water systems (“Eastern
    Group Case”). The next year AWC filed a similar rate case for its northern
    group water systems (“Northern Group Case”). In both cases AWC sought
    a rate increase and proposed a step-increase mechanism that would allow
    the Commission to adjust rates between full rate cases. AWC argued that
    recouping the costs of its infrastructure improvements through the
    traditional mechanism would require a near-continuous series of lengthy
    *
    Justice Clint Bolick recused himself from this case. Pursuant to article 6,
    section 3, of the Arizona Constitution, the Honorable Christopher Staring,
    Judge of the Arizona Court of Appeals, Division Two, was designated to sit
    in this matter.
    3
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    rate cases, raising costs and exposing consumers to “rate shock” from
    sudden, dramatic rate increases.
    ¶3           Attempting to settle the rate cases, AWC proposed the SIB
    mechanism, which allows AWC to petition for a rate increase between rate
    cases as new AWC infrastructure projects become active. See infra ¶¶ 7–9.
    Despite opposition from the Residential Utility Consumer Organization
    (“RUCO”), the Commission approved, with some modifications, the SIB
    mechanism.
    ¶4             RUCO appealed. The court of appeals consolidated the
    Eastern Group and Northern Group cases and vacated the Commission’s
    approval of the SIB mechanism. Residential Util. Consumer Office v. Ariz.
    Corp. Comm'n, 
    238 Ariz. 8
    , 9–10 ¶ 1, 
    355 P.3d 610
    , 611–12 (App. 2015).
    Concerned the Commission would not consider all elements of a general
    rate case proceeding when analyzing an SIB surcharge petition, the court
    concluded that the SIB (1) did not fall within previously recognized
    exceptions to the fair value requirement, and (2) did not “provide[] the
    functional equivalent of a fair value determination.” 
    Id. at 17–18
    ¶¶ 47, 
    50, 355 P.3d at 619
    –20. As a result, the court held that “the SIB mechanism does
    not comply with the Arizona Constitution’s mandate that the Commission
    determine a public service corporation’s fair value when setting rates[.]” 
    Id. at 10
    1, 355 P.3d at 612
    .
    ¶5            We granted review because the scope of the Corporation
    Commission’s constitutional authority to adopt new ratemaking
    mechanisms is an issue of statewide importance. We have jurisdiction
    under article 6, section 5(3), of the Arizona Constitution and A.R.S. § 12-
    120.24.
    B. Ratemaking: full rate cases and the SIB mechanism
    ¶6             The Commission is constitutionally charged with setting “just
    and reasonable rates.” Ariz. Const. art. 15, § 3. The Commission sets rates
    by finding the “fair value” of a utility’s in-state property, Ariz. Const. art.
    15, § 14, and then using that value as the “rate base” in the following rate-
    of-return formula: (Rate Base x Rate of Return) + Expenses = Revenue
    Requirement. US West Commc’ns, Inc. v. Ariz. Corp. Comm’n, 
    201 Ariz. 242
    ,
    245 ¶ 13, 
    34 P.3d 351
    , 354 (2001). The Commission determines rates using
    a proceeding called a “rate case,” now codified as Arizona Administrative
    4
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    Code (A.A.C.) R14-2-103 (“Rule 103”). Rule 103 or “full” rate case
    proceedings are complex. They typically attract many intervenors, require
    voluminous and detailed filings, and involve multiple, lengthy hearings. A
    Rule 103 rate case for a utility like AWC often takes more than a year to
    process.
    ¶7            The SIB mechanism allows the Commission to adjust rates in
    between rate cases, subject to various requirements and conditions. Under
    the SIB framework, AWC must file a full rate case at least once every five
    years. Within the rate case, the Commission must evaluate and pre-
    approve all SIB-eligible infrastructure replacement projects. During the
    interim years, AWC may file for only one SIB surcharge per year. Before a
    project may be incorporated in the SIB surcharge calculation, it must be
    completed and actively serving customers.
    ¶8             When AWC requests an SIB surcharge, it must submit current
    financial documents, including a balance sheet reflecting the value of its
    property—both older infrastructure and newly-constructed SIB projects
    that are in use. The tax multiplier, depreciation rate, and authorized rate of
    return used in calculating the SIB must be the same as those approved by
    the Commission in the most recent rate case. Before a surcharge may take
    effect, the Commission must provide 30-days public notice and receive and
    consider objections.
    ¶9             Every year the Commission must conduct a “true-up”
    calculation to reconcile revenue collected through the SIB surcharge with
    revenue authorized for the previous period. Any over-collection is re-
    funded to customers. To compensate for efficiency-based savings resulting
    from the improved infrastructure, AWC must issue a credit to customers in
    the form of a refund equal to five percent of the SIB surcharge. Both the SIB
    surcharge and efficiency credit must be clearly displayed on customers’
    bills.
    II.    DISCUSSION
    A. Standard of review
    ¶10            Whether the SIB mechanism complies with the Arizona
    Constitution is a question of law we review de novo. See US 
    West, 201 Ariz. at 244
    7, 34 P.3d at 353
    . We generally presume the Commission’s actions
    5
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    are constitutional, and we uphold them unless they are arbitrary or an
    abuse of discretion. Ariz. Corp. Comm’n v. Ariz. Pub. Serv. Co., 
    113 Ariz. 368
    ,
    371, 
    555 P.2d 326
    , 329 (1976); Simms v. Round Valley Light & Power Co., 
    80 Ariz. 145
    , 154, 
    294 P.2d 378
    , 384 (1956).
    B. The Arizona Constitution grants the Commission broad
    discretion within its unique decision-making sphere
    ¶11            “The Arizona Corporation Commission, unlike such bodies in
    most states, is not a creature of the legislature, but is a constitutional body
    which owes its existence to provisions in the organic law of this state.”
    Ethington v. Wright, 
    66 Ariz. 382
    , 389, 
    189 P.2d 209
    , 214 (1948); see Ariz.
    Const. art. 15 (“The Corporation Commission”), §§ 1–19. As relevant here,
    the powers and duties of the Commission are described in article 15, § 3:
    The corporation commission shall have full power to, and
    shall, prescribe just and reasonable classifications to be used
    and just and reasonable rates and charges to be made and
    collected, by public service corporations within the state for
    service rendered therein, and make reasonable rules,
    regulations, and orders, by which such corporations shall be
    governed in the transaction of business within the state[.]
    Regarding the Commission performing these duties, article 15, § 14,
    provides:
    The corporation commission shall, to aid it in the proper
    discharge of its duties, ascertain the fair value of the property
    within the state of every public service corporation doing
    business therein; and every public service corporation doing
    business within the state shall furnish to the commission all
    evidence in its possession, and all assistance in its power,
    requested by the commission in aid of the determination of
    the value of the property within the State of such public
    service corporation.
    ¶12            The Commission has full and exclusive power to set “just and
    reasonable rates” for public service utilities. See Ariz. Const. art. 15, § 3; see
    also State v. Tucson Gas, Electric Light & Power Co., 
    15 Ariz. 294
    , 306, 
    138 P. 781
    , 786 (1914). As we have previously observed:
    6
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    [I]n the matter of prescribing classifications, rates, and
    charges of public service corporations and in making rules,
    regulations, and orders concerning such classifications, rates,
    and charges by which public service corporations are to be
    governed, the Corporation Commission has full and exclusive
    power. In such field the Commission is supreme and such
    exclusive field may not be invaded by the courts, the
    legislature, or the executive.
    
    Ethington, 66 Ariz. at 392
    , 189 P.2d at 216; see also Tucson 
    Gas, 15 Ariz. at 301
    03, 138 P. at 784
    –85 (holding that because article 14, § 6, of the Arizona
    Constitution authorizes the state legislature to enlarge the powers and
    extend the duties of the Commission, the Constitution impliedly prohibits
    the legislature from exercising powers assigned to the Commission); Ariz.
    Pub. Serv. 
    Co., 113 Ariz. at 371
    , 555 P.2d at 329 (“We would not presume to
    instruct the Commission as to how it should exercise its legislative
    functions.”).
    C. The Commission must use current fair value as the basis for
    setting rates for monopoly, for-profit utilities
    ¶13            The Commission generally must use its determination of fair
    value as the basis for calculating a reasonable return on a utility’s
    investment and, in turn, a proper rate. Ariz. Corp. Comm’n v. Ariz. Water
    Co., 
    85 Ariz. 198
    , 202, 
    335 P.2d 412
    , 414 (1959); see supra ¶ 6. Although this
    “traditional approach” is not constitutionally required in all cases, see US
    
    West, 201 Ariz. at 246
    19, 34 P.3d at 355
    (considering ratemaking for a
    utility in a competitive industry and finding that “[i]n such a climate, there
    is no reason to rigidly link the fair value determination to the establishment
    of rates”), we have repeatedly required its use in ratemaking for private,
    for-profit monopolies like AWC. 
    Simms, 80 Ariz. at 151
    , 294 P.2d at 382; see
    also US 
    West, 201 Ariz. at 246
    19, 34 P.3d at 355
    (“We still believe that when
    a monopoly exists, the rate-of-return method is proper.”). Similarly, we
    have held that, with some limited exceptions, fair value must be determined
    when rates are set. Ariz. Water 
    Co., 85 Ariz. at 201
    02, 335 P.2d at 414
    –15;
    
    Simms, 80 Ariz. at 151
    , 294 P.2d at 382. As a result, in order to fix just and
    reasonable rates for AWC and other for-profit monopoly utilities, the
    Commission is obligated to base rates on the current fair value of the
    utility’s property.
    7
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    D. The fair value requirement applies only to the “rate base”
    variable of the traditional ratemaking formula
    ¶14             Under Arizona’s Constitution, the “fair value” requirement
    applies only to the “rate base” element of the traditional ratemaking
    equation. US 
    West, 201 Ariz. at 245
    13, 34 P.3d at 354
    ; see supra ¶ 6. The
    rate base element involves a calculation of, in the Constitution’s language,
    “the fair value of the [utility’s] property within the state.” Ariz. Const. art.
    15, § 14. On the other hand, the rate of return, expenses, and revenue
    requirement elements do not measure the value of the utility’s assets. In
    Arizona Public Service Company, we explained, “Under the constitution as
    interpreted by this court, the Commission is required to find the fair value
    of the company’s property and use such finding as a rate base for the purpose
    of determining what are just and reasonable 
    rates.” 113 Ariz. at 370
    , 555
    P.2d at 328 (citing Simms, 
    80 Ariz. 145
    , 
    294 P.2d 378
    ) (emphasis added); see
    also Scates v. Ariz. Corp. Comm’n, 
    118 Ariz. 531
    , 534, 
    578 P.2d 612
    , 615 (App.
    1978) (“[T]he Commission must first determine the ‘fair value’ of a utility’s
    property and use this value as the utility’s rate base.”). Accordingly, we
    reject RUCO’s argument that “fair value” somehow encompasses the
    determination of the appropriate rate of return.
    E. The SIB contains a reasonable method for determining
    AWC’s fair value rate base
    ¶15            The Commission is required to ascertain the fair value of the
    company’s property and use that value as a rate base for calculating just
    and reasonable rates. 
    Simms, 80 Ariz. at 151
    , 294 P.2d at 382. But the
    “constitution does not establish a formula for arriving at fair value” and we
    have never prescribed one. Id.; Ariz. Water 
    Co., 85 Ariz. at 202
    , 335 P.2d at
    414. The method for determining fair value, then, falls within the
    Commission’s discretion, and we will uphold a fair value determination
    unless it “is arbitrary and unfair at the time it is made.” Ariz. Pub. Serv. 
    Co., 113 Ariz. at 371
    , 555 P.2d at 329. A full rate case is one permissible method
    for determining fair value. Such a proceeding, however, is a product of the
    Commission’s own rules and practice, see Rule 103. It is not constitutionally
    mandated.
    ¶16         As the Commission explained in its decision, the SIB
    mechanism is based on the fair value rate base of AWC’s property. The
    mechanism uses the fair value determination made in the previous rate case
    8
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    and adds the value of the infrastructure improvements once they are made.
    AWC must submit up-to-date financial statements with each SIB surcharge
    application, including an adjusted rate base schedule in which the value of
    operational SIB projects is added to the underlying rate base from the
    previous rate case. Using these financial statements, the Commission will
    also update the fair value rate base and other elements of the formula from
    the most recent rate case to “recognize changes in plant, accumulated
    depreciation, contributions in aid of construction, advances in aid of
    construction, and accumulated deferred income taxes . . . .” Ariz. Corp.
    Comm’n, Decision No. 73938 at 51, W-01445A-11-0310, 
    2013 WL 5408684
    (June 27, 2013). Although the Commission will not re-calculate anew every
    input into the fair value determination, this updated measurement satisfies
    the constitutional requirement that the Commission “ascertain the fair
    value” of a public utility’s property “to aid it in the proper discharge of its
    duties.” Ariz. Const. art. 15, § 14.
    ¶17            In finding that the Commission abused its discretion, the
    court of appeals took a restrictive view of the requirement that the
    Commission “ascertain the fair value” of a public utility “to aid” it in setting
    rates. The court seemed to equate the full rate case procedure with the
    constitutional requirement that the Commission determine the fair value of
    a utility’s property, frequently using the terms “rate case” and “fair value
    determination” interchangeably. See, e.g., Residential Util. Consumer Office,
    
    238 Ariz. 8
    , 13 ¶ 27, 14 ¶ 33, 16 ¶ 40, 17 ¶¶ 45, 47, 18 ¶ 49, 
    355 P.3d 610
    , 615–
    620. Because the fair value mechanism calculation within the SIB does not
    require all the filings that would form part of a rate case, the court of
    appeals concluded that the SIB was “inconsistent with the mandate that the
    Commission perform a fair value determination ‘at the time of inquiry.’”
    
    Id. at 17
    42, 355 P.3d at 619
    (quoting Ariz. Corp. 
    Comm’n, 85 Ariz. at 201
    02, 335 P.2d at 414
    –15).
    ¶18           In ruling that the SIB fails to properly assess current fair value
    when setting rates, the court of appeals analyzed whether the SIB
    mechanism could be upheld as an interim rate or an adjustor mechanism—
    two ratemaking mechanisms that, under narrow circumstances set forth in
    court of appeals cases, permit the Commission to approve rates without
    making a current finding of fair value. See Residential Util. Consumer 
    Office, 238 Ariz. at 12
    21, 355 P.3d at 614
    ; Residential Util. Consumer Office v. Ariz.
    Corp. Comm’n, 
    199 Ariz. 588
    , 591 ¶ 11, 
    20 P.3d 1169
    , 1172 (App. 2001); 
    Scates, 118 Ariz. at 535
    , 578 P.2d at 616; see also Ariz. Corp. Comm’n v. Mountain
    9
    RUCO V. AZ CORP COMMISSION/AZ WATER CO.
    Opinion of the Court
    States Tel. & Tel. Co., 
    71 Ariz. 404
    , 412–13, 
    228 P.2d 749
    , 754–55 (1951). The
    court found that the SIB resembled neither pre-approved mechanism. We
    agree that the SIB is neither an interim rate nor an adjustor mechanism, but
    we disagree that this ends the inquiry. As we explained above, SIB rate
    adjustments will be based on a current finding of the fair value of AWC’s
    property. By supplementing and updating the fair value determination
    from a previous rate case, the SIB satisfies the constitutional mandate that
    the Commission determine fair value to aid it in setting rates.
    ¶19            In reaching its conclusion, the court of appeals relied heavily
    on its opinion in Scates. That case, however, is inapposite. In Scates, the
    court found that the Commission abused its discretion by imposing a rate
    increase without considering any measure of fair 
    value. 118 Ariz. at 534
    , 578
    P.2d at 615. Such an increase, the court held, could not be justified as an
    adjustor mechanism or interim rate. 
    Id. at 535–36,
    578 P.2d at 616–17. The
    Scates court, however, did not assert that fair value can only be ascertained
    through a full rate case; instead, it explicitly did not foreclose the possibility
    that the Commission could satisfy the requirement by referring to
    “previous submissions with some updating” or to “summary financial
    information.” 
    Id. at 537,
    578 P.2d at 618. The SIB mechanism—grounded
    in a current determination of fair value—comports with Scates, the Arizona
    Constitution, and this Court’s cases.
    III.   CONCLUSION
    ¶20          As required by the Arizona Constitution, under the SIB
    mechanism, the Corporation Commission will “ascertain the fair value” of
    AWC’s property and use that determination “to aid” it in setting SIB
    surcharge rates. As a result, we vacate the court of appeals’ opinion and
    affirm the Commission’s orders approving the SIB mechanism.
    10