Utah Bar Journal

While a future test year provides a sharing of risks for items such as fuel, purchased power, labor, benefits, administration, etc., which have a price and volume risk profile, construction has a completely different risk profile. With construction, the price risk is solved by the bidding process so that it is transferred to the contractor. That leaves the completion risk – whether the asset is operational on time, or completed at all. Under Utah law, it is the investor who is supposed to bear the risk of loss as a developer of a public utility.

Used and useful has always provided the “bright-line” demarcation for the risk of completion of construction. Nevertheless, that does not mean the utility is without recovery during that time. The utility is collecting its allowance of funds used during construction (“AFUDC”). In Utah, it also has the option of filing for recovery of major plant additions.

The Principle of Used and Useful Is the Bedrock of Utility Regulation.
In determining whether the state of Illinois had taken the property of grain warehousemen by legislating a maximum rate for grain storage, the United States Supreme Court in Munn v. Illinois, 94 U.S. 113 (1876), set forth the historic theory underlying public regulation of private property:

[W]hen private property is affected with a public interest, it ceases to be juris privati only.… Property does become clothed with a public interest when used in a manner to make it of public consequence, and affect the community at large. When, therefore, one devotes his property to a use in which the public has an interest, he, in effect, grants to the public an interest in that use, and must submit to be controlled by the public for the common good, to the extent of the interest he has thus created. He may withdraw his grant by discontinuing the use; but, so long as he maintains the use, he must submit to the control.

Id. at 126 (citation and internal quotation marks omitted).

Several years later, in Smyth v. Ames, 169 U.S. 466 (1898), the Court formulated for the first time a coherent test of the extent to which regulated companies were protected from legislative expropriation on behalf of the public. See id. at 546-47. In doing so, the Court, in weighing the considerations of equity between the interests of the providers and the consumers of a service, tied together what is or is not physically used and useful to the public service being provided. See id.

We hold, however, that the basis of all calculations as to the reasonableness of rates to be charged by a corporation maintaining a highway under legislative sanction must be the fair value of the property being used by it for the convenience of the public.… What the company is entitled to ask is a fair return upon the value of that which it employs for the public convenience. On the other hand, what the public is entitled to demand is that no more be exacted from it for the use of a public highway than the services rendered by it are reasonably worth.

Id. (emphases added); see also W. Ohio Gas Co. v. Pub. Utils. Comm’n, 294 U.S. 63, 66 (1935) (basing decision in part on the “final order of valuation, made in January, 1932, whereby the value of property in Lima, [Ohio,] used and useful for the business, was fixed” (emphasis added)); Bluefield Water Works & Improvement Co. v. Pub. Serv. Comm’n, 262 U.S. 679, 692 (1923) (“A public utility is entitled to such rates as will permit it to earn a return on the value of the property which it employs for the convenience of the public.” (emphasis added)).

The Smyth Court set forth the idea that the only property eligible to earn a rate of return is the property used to serve the public. See Smyth, 169 U.S. at 546-47. The public can demand physical use of such property so the regulated entity is entitled to earn a rate of return on that property. See id.

Thereafter, the principle of used and useful became widely used not only to identify those assets that were “taken for public use” and for which private companies were entitled to a fair return from the public, but also to serve the role of placing definite limitations on the cost responsibilities of the persons receiving utility services.2 Justice Cardozo explained this approach in Columbus Gas & Fuel Co. v. Public Utilities Commission:

There will be no need in the computation of the rate base to include the market or the book value of fields not presently in use, unless the time for using them is so near that they may be said, at least by analogy, to have the quality of working capital. The arrival of that time cannot be known in advance through the application of a formula, but within the margin of a fair discretion must be determined for every producer by the triers of the facts in the light of all the circumstances. The burden is on the gas company to supply whatever testimony may be necessary to enable court or board to make the requisite division. Leases bought with income, the proceeds of the sale of gas, and thus paid for in last analysis through the contributions of consumers, ought not in fairness to be capitalized until present or imminent need for use as sources of supply shall have brought them into the base upon which profits must be earned. To capitalize them sooner is to build the rate structure of the business upon assets held in idleness to abide the uses of the future.

292 U.S. 398, 406-07 (1934) (emphasis added).

Another good example is Denver Union Stock Yard Co. v. United States, 304 U.S. 470 (1938). In this case, the Denver Union Stock Yard Company challenged the rates set for its services by the Secretary of Agriculture as being confiscatory. See id. at 473-74, The Court affirmed after reviewing the evidence, which demonstrated that the Secretary had only excluded property not physically used and useful for performance of stockyard services covered by the rates. See id. at 475.

The Court’s decision in Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944), shifted rate base formulation from fair value to prudent investment, but the physical used and useful test prevailed. See id. at 603-06. For example, in Tennessee Gas Pipeline Co. v. FERC, 606 F.2d 1094 (D.C. Cir. 1979), the Court of Appeals for the District of Columbia held,

In Smyth v. Ames, the Supreme Court articulated the guiding principle that

“the basis of all calculations as to the reasonableness of rates to be charged by a (public utility) must be the fair value of the property being used by it for the convenience of the public.” Although methods for determining values of rate base items have evolved since Smyth v. Ames, the precept endures that an item may be included in a rate base only when it is ‘used and useful’ in providing service. In other words, current rate payers should bear only legitimate costs of providing service to them. The FPC [forerunner to FERC] early adopted the “used and useful” standard and has not departed from it without careful consideration of the wisdom of requiring current rate payers to bear costs of providing future service.

Smyth v. Ames, 169 U.S. 466, 546 (1898) (emphasis added) (citations omitted); see also Natural Gas Pipeline Co. of Am. v. FERC, 765 F.2d 1155, 1157 (D.C. Cir. 1985) (“In calculating the utility’s cost of service the Commission includes its operating expenses, depreciation expenses, taxes, and a reasonable return on the net valuation of the property devoted to the public service.… The Commission decides what property is devoted to the public service by asking whether the property is ‘used and useful’ in serving the public.” (citation omitted)); In re S. Nat’l Gas Co., 130 FERC P 61,193 at ¶ 30, 2010 (noting that in establishing rates, FERC has traditionally included only costs relating to utility plant that is physically used and useful in providing utility service).

Later, some type of cost recovery was allowed in certain narrow cases and for many nuclear power plants that were planned in the 1960s and 1970s, but that were either cancelled or abandoned while only partially built. The regulatory and legal decisions regarding these assets established the economic used and useful concept. See Jonathan A. Lesser, The Used and Useful Test: Implications for a Restructured Electric Industry, 23 Energy L.J. 349 (2002). That concept is not discussed here. The subject of this article pertains only to the physical used and useful principle for regulatory cost recovery, which still prevails in Utah.

The Principle of Used and Useful Has Long Been a Core Precept of Utah Law.
As the Utah Supreme Court has held,

[U]nder the general concepts of public utility law, risk capital is provided by the investor; it is this group which bears the risk of loss as developer of a public utility. It is only to the extent the facilities developed are used and useful to the consumer that they are included in the rate base.

Comm. of Consumer Servs. v. Pub. Serv. Comm’n, 595 P.2d 871, 874 (Utah 1979) (Wexpro Case) (emphasis added). In the Wexpro Case, the Utah Supreme Court noted that the commission had modified the traditional principles of utility law in this particular case based on the broad statutory definition of gas plant, which allowed undeveloped acreage to be deemed an asset used and useful to the rate payers in the production of gas. See id. at 875. The used and useful principle was still followed, but the broad statutory definition of gas plant expanded the asset to which it could be applied. See id. Therefore, “a utility is usually precluded from including in the rate base any capital asset, until it is developed, and then only to the extent the asset is used and useful in rendering the consumer service.” Id.; see also Utah Dep’t of Bus. Reg. v. Pub. Serv. Comm’n, 614 P.2d 1242, 1248 (Utah 1980) (“A just and reasonable rate is one that is sufficient to permit the utility to recover its cost of service and a reasonable return on the value of property devoted to public use.” (emphasis added)). The Wexpro court relied on long established Utah law for its decision.

In 1944, the Utah Supreme Court affirmed the ruling of the Utah Public Service Commission (“Commission”) directing a reduction in rates charged by the electric utility because the “just and proper rate base for the [utility] is the amount actually and ‘prudently invested’ in the property used and useful in rendering Utah service.” Utah Power & Light Co. v. Pub. Serv. Comm’n, 152 P.2d 542, 546 (Utah 1944). In that case, the Utah Supreme Court took considerable effort to explain the long development of the physical used and useful principle. See id. at 551. In doing so, the court noted,

The Denver Stock Yard case is of interest because of the fact that it was decided during a period when it appeared that important limitations were being placed on the “fair value” doctrine of Smyth v. Ames, yet it emphatically laid down the rule that as of right safeguarded by the due process clause of the Fifth Amendment, appellant is entitled to rates not per se excessive and extortionate, sufficient to yield a reasonable rate of return upon the value of property used, at the time it is being used, to render the services.

Id. (emphasis added)(internal quotation marks omitted). In a separate part of the case, wherein the court discussed the calculation of net income, it stated, “[T]he public should not in any event be forced to pay rates based on the amount paid in by stockholders unless the amount paid is represented in properties used and useful in serving the public.” Id. at 570 (emphasis added).

While it is true that in this case the Utah Supreme Court was evaluating the use of fair value of regulatory assets in setting rates, it did so in the context of implementing the used and useful principle and explaining the continuing importance of that principle to rate making. For instance, the court noted that despite the United States Supreme Court’s decision in Federal Power Commission v. Hope Natural Gas Co., 320 U.S. 591 (1944), to abandon the fair value rule, the utility had insisted the Commission was required to fix utility rates on a fair value basis. See Utah Power & Light, 152 P.2d at 546. The court then noted that the Commission had instead adopted a directly contrary position based on used and useful assets. See id. The Commission had “held that the just and proper rate base for the Company [wa]s the amount actually and ‘prudently invested’ in the property used and useful in rendering Utah service.” Id. (emphasis added).

The court further noted that when the United States Supreme Court developed the “fair value” rule as the test of reasonableness of rates in Smyth v. Ames, it specifically “announced the rule that the owner of private property devoted to a public use is entitled to a ‘fair return’ on the ‘fair value’ of his property devoted to public use.” Id. at 548 (emphasis added). Note, the court did not state that the return was provided on property to be devoted to public use in the future, but to property devoted to public use.

The Utah Supreme Court also noted that the Denver Union Stock Yard Co. v. United States, 304 U.S. 470 (1938), case “is worthy of note in the development of the law in this regard.” Id. at 550. In fact, the Utah court specifically mentioned this case:

[B]ecause of the fact that it was decided during a period when it appeared that important limitations were being placed on the “fair value” doctrine of Smyth v. Ames, yet it emphatically laid down the rule that “as of right safeguarded by the due process clause of the Fifth Amendment, appellant is entitled to rates not per se excessive and extortionate, sufficient to yield a reasonable rate of return upon the value of property used, at the time it is being used, to render the services.”

Id. at 551 (emphasis added) (citations omitted). The used and useful principle was critical to the Utah Supreme Court’s holding to affirm the Commission’s decision to abandon the fair value analysis and rule that the “just and proper rate base for the Company [wa]s the amount actually and ‘prudently invested’ in the property used and useful in rendering Utah service.” Id. at 546, 558 (emphasis added). In Terra Utilities, Inc. v. Public Service Commission, 575 P.2d 1029 (Utah 1978), the Utah Supreme Court affirmed the Commission’s decision to reject a proposed rate increase for water and sewer services in a development project. See id. at 1033. The Terra court upheld the Commission’s decision that because at the time only 20.76% of the water system was physically used and useful and only 19.83% of the sewer system was physically used and useful, the proposed rates that intended to include 100% of the costs of each were not just and reasonable. See id. at 1031-32.

The Commission has consistently relied on the physical “used and useful” principle.

[R]atepayers should not bear the overall authorized return until such time as an asset becomes a productive source of service revenue or expense savings. At that time, full cost recovery occurs as the entire investment is included in rate base and then depreciated.… We continue to uphold the efficacy of the used and useful ratemaking principle because it demarcates an asset’s in-service and productive status which in turn triggers capital recovery of the engineered, furnished and installed cost of the asset, including capitalized interest.

In re U.S. W. Commc’ns, Inc., Docket No. 97-049-08 (Utah P.S.C. Dec. 4, 1997) (emphasis added); see also In re SCSC, Inc., Docket No. 94-2196-01, 1994 WL 570658 (Utah P.S.C. Sept. 15, 1994) (ordering that “it must be absolutely clear that the rate-payer is not being asked to cover the cost of a system which is larger than needed (and thus not used and useful)”).

Summary
The used and useful test is clearly not unusable and useless in the world of traditional regulation. It is still viable and valuable in Utah and is one of the regulatory oversight tools that should be used to protect ratepayers.

1. Often title of ownership does not pass to the utility until the asset becomes commercially in-service. If the utility begins recovering costs before the facilities become used and useful, ratepayers are paying the electric utility for assets it actually does not even yet own.

2. The used and useful principle is thus a balancing between the public service provider and the public. The public has certain rights to what is otherwise private property and the public must pay for those rights, but only to the extent that the public may actually physically enjoy those rights.