18.2 III. Rcnld Vs. “Rate Base”

JurisdictionNew York

III. RCNLD VS. “RATE BASE”

Axiomatically, the historic earnings of an enterprise are one indication of the enterprise’s value. For public utilities, however, government regulators, rather than market forces, have largely dictated the levels of those earnings. The thorniest “just compensation” problem for public utility property is the impact of rate regulation on calculating just compensation.

The rate regulation of public use entities has long been recognized as a form of taking for the public good governed by the same “just compensation” requirements of the Fifth and Fourteenth Amendments that govern condemnation awards.662 Thus, rate regulation has always had to allow owners a reasonable opportunity to recover their current expenses together with a “fair return” on capital. The proper identity of the “base” upon which this fair return was to accrue, or “rate base,” was long a thorny issue. Originally, the Supreme Court concluded that the rate base had to equal the “fair value” of the entire utility enterprise delivering the utility service, including both the tangible and intangible “going concern” assets of these systems.663 Since there were no reliable market sales of these systems and since the earnings of these systems themselves were the end product of the ratemaking process, the fair value of both tangible and intangible components of these systems had to be determined primarily through the RCNLD methodology.664 Over time, this RCNLD approach proved to be excessively complex and unworkable.

In 1944, the Supreme Court held in Federal Power Commission v. Hope Natural Gas Co.665 that a rate base founded on original cost less depreciation (OCLD) (i.e., net book value) was constitutional so long as the return on this rate base was commensurate with the market based returns on investments of similar risk. Since then, virtually all utility regulators have adopted OCLD ratemaking.

Under OCLD ratemaking, rates are set at a level calculated to enable owners to recover their operating costs (including taxes and depreciation) together with a fair return on the depreciated original cost of plant-in-service and working capital. The theory underlying the OCLD approach is that the thing the utility investor is dedicating to the public use and upon which the investor is hence entitled to a fair return, is not really the operating public service enterprise but the amount of capital invested in this enterprise.

Original Cost Less Depreciation ratemaking made...

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