SFPP v. Public Util. Com.

 

 

 

 

 

 

 

 

 

Filed 6/13/13  SFPP v. Public Util. Com. CA4/3

 

 

 

 

 

 

 

>NOT TO BE PUBLISHED IN OFFICIAL REPORTS

 

California
Rules of Court, rule 8.1115(a), prohibits courts and parties from citing or
relying on opinions not certified for publication or ordered published, except
as specified by rule 8.1115(b).  This
opinion has not been certified for publication or ordered published for
purposes of rule 8.1115.

 

 

 

IN THE COURT OF
APPEAL OF THE STATE OF CALIFORNIA

 

FOURTH
APPELLATE DISTRICT

 

DIVISION THREE

 

 
>

SFPP, L.P.,         Petitioner,               v.   PUBLIC UTILITIES COMMISSION,         Respondent;   CHEVRON PRODUCTS COMPANY et al.,         Real Parties in Interest.

G046669            (Cal.P.U.C. Dec. Nos. 11-05-045,           12-03-026)            O P I N I O N

 

                        Original proceedings;
petition for a writ of review of decisions of the California Public Utilities
Commission.  Petition denied.

 

 

                        Mayer Brown, Donald M.
Falk, Neil M. Soltman and Eileen Penner for Petitioner.

                        Frank R. Lindh, Helen W.
Yee and Pamela Nataloni for Respondent.

                        Baker Botts, Thomas J.
Eastment, Gregory S. Wagner; Ropers, Majeski, Kohn & Bentley and Susan H.
Handelman for Real Parties in Interest BP West Coast Products and ExxonMobil
Oil Corporation.

                        Weber & Associates,
George L. Weber; Orrick, Herrington & Sutcliffe and Joseph M. Malkin for
Real Party in Interest Chevron Products Company.

                        Dorsey & Whitney,
Martha C. Luemers and Marcus W. Sisk, Jr., for Real Party in Interest Phillips
66 Company.

                        Venable, Steven A.
Adducci, Richard E. Powers, Jr., and Douglas C. Emhoff for Real Parties in
Interest Southwest Airlines Co., Ultramar Inc., and Valero Marketing and Supply
Company.

                        McGuireWoods and A.
Brooks Gresham for Real Party in Interest Tesoro Refining and Marketing
Company.

I

INTRODUCTION

                        Petitioner SFPP, L.P.
(SFPP) is a Delaware limited partnership that operates both intrastate and
interstate oil pipelines.  SFPP’s
upstream owners are Kinder Morgan Energy Partners, L.P., a publicly traded
partnership, which, through one of its operating partnerships, Kinder Morgan
Operating L.P. “D” (which itself is partly owned by Kinder Morgan, Inc.) owns
99.5 percent of SFPP.  The other .5
percent is owned by Santa Fe Pacific Pipelines, Inc., a wholly owned, indirect
subsidiary of Burlington Northern Santa Fe Corporation. 

                        Respondent Public
Utilities Commission of the State of California (the PUC) is the agency charged
with regulating public utilities pursuant to Article XII of the California
Constitution and the Public Utilities Act,href="#_ftn1" name="_ftnref1" title="">[1]
and accordingly, it regulates SFPP’s intrastate pipelines. 

                        Real parties in interest Chevron
Products Company, Phillips 66 Company, BP West Coast Products LLC, ExxonMobil
Oil Corporation, Southwest Airlines Co., Tesoro Refining and Marketing Company,
Ultramar Inc., and Valero Marketing and Supply Company (collectively the
Shippers) are oil companies and an airline operator that use and
pay for SFPP’s services on its pipeline facilities. 

                        SFPP
petitions for a writ of review of two of the PUC’s ratesetting orders,
specifically ARCO Prods.
Co. v. Santa Fe Pacific Pipeline, L.P. (2011) Dec. No. 11-05-045 [2011 Cal.P.U.C.
Lexis 299]
(SFPP I
or the Final Decision), and the order on rehearing, ARCO Prods. Co. v. Santa Fe Pacific
Pipeline, L.P. (2012) Dec. No.12-03-026 [2012 Cal.P.U.C. Lexis 135] (SFPP II or the Rehearing
Decision)
(collectively the Decisions).  >SFPP II granted limited rehearing,
modified SFPP I in part, and denied
rehearing as to all other issues.  (>SFPP II, supra, 2012
Cal.P.U.C. Lexis 135 at p.
*4.) 

                        “The
PUC is not an ordinary administrative agency, but a constitutional body with
far-reaching powers, duties and functions. 
[Citations.]  The Constitution
confers broad authority on the PUC to regulate utilities, including the power
to fix rates, establish rules, hold various types of hearings, award
reparations, and establish its own procedures. 
[Citation.]”  (>Utility Consumers’ Action Network v. Public
Utilities Com. (2004) 120 Cal.App.4th 644, 654.) 

                        The
PUC’s jurisdiction “includes the authority to determine and fix ‘just,
reasonable [and] sufficient rates’ [citation] to be charged by the
utilities.”  (Southern California
Edison Co. v. Peevey (2003) 31 Cal.4th 781, 792.)  The California Supreme Court “has endorsed
the commission’s position:  ‘“The basic
principle [of ratemaking] is to establish a rate which will permit the utility
to recover its cost and expenses plus a reasonable return on the value
of property devoted to public use.” 
[Citation.]’”  (>Southern
Cal. Gas Co. v. Public Utilities Com. (1979) 23 Cal.3d 470, 476.)

                        SFPP
argues the PUC’s Decisions made two errors in its ratesetting orders.  First, SFPPhref="#_ftn2" name="_ftnref2" title="">[2]
argues the PUC erroneously denied it a federal income tax allowance because it
is a limited partnership instead of a corporation.  SFPP strains mightily to frame the PUC’s
decision as one based on incorrect legal interpretations.  It also argues the Decisions are contrary to
the PUC’s own factual findings, are an abuse of discretion, and are in
violation of due process.  None of these
arguments are supported by the record and the relevant law.  In essence, the PUC’s decision regarding the
treatment of partnerships for tax purposes is a policy question, and thus, not
subject to reversal by this court.

                        Second,
SFPP claims the PUC set an unreasonably low return on equity, arguing the PUC
used a flawed methodology and failed to use a valid proxy group in its rate
calculations.  We reject SFPP’s arguments
on this point as unsupported by the evidence and the Decisions, and conclude
the PUC did not abuse its discretion in its calculation of an appropriate
return on equity.

II

RELEVANT
FACTS AND PROCEDURAL BACKGROUND

                        The Decisions before us involve numerous
consolidated proceedings dating back to 1997. 
(SFPP I, supra, 2011 Cal.P.U.C.
Lexis 299 at p. *2.)  In the interests of
brevity, we do not detail the entire history of the proceedings, but only those
parts relevant to the issues before us.

                        In
1991, SFPP sought a rate increase from the PUC for the first time since
1985.  It was uncontested, and in 1992,
the PUC granted SFPP a 9 percent increase. 
(In re SFPP (1992) 44 Cal.P.U.C.2d 200 [1992 Cal.P.U.C. Lexis 499].)  

                        In
1997, the Shippers filed a complaint with the PUC contesting SFPP’s rates.  (See ARCO Prods. Company v. SFPP, LP (1998) 81 Cal.P.U.C.2d 573 [1998 Cal.P.U.C.
Lexis 593]
(ARCO Prods. Company).)  The Shippers asserted that
because SFPP was a limited partnership, it does not incur federal income tax
liability and its net income after taxes was identical to its net income before
taxes.  (Ibid.)  SFPP conceded “that it is a
publicly traded partnership which itself incurs and pays no income tax and that
its affiliated corporate unitholders may incur no federal income tax liability
on income generated by defendant because of the
availability of interest payment offsets under a consolidated income tax
return.  However, defendant argues, the
taxable income that is generated by it as a partnership does not escape
taxation:  It is taken into income by its
partners.”  (Ibid.)  

                        Thus,
initially, the PUC rejected the Shippers’ challenge, noting, with respect to
the tax allowance, that the 1992 rate setting was adopted “in full recognition
that defendant was organized as a limited partnership.”  ARCO
Prods. Company v. SFPP, LP, supra, 1998 Cal.P.U.C.
Lexis 593 at page 45.  In 1999, however, the PUC granted
rehearing.  (ARCO Prods. Company v. SFPP, LP (1999) 1
Cal.P.U.C.3d 418 [1999 Cal.P.U.C. Lexis 442] (ARCO Prods. Company
Rehearing).) 

                        ARCO
Prods. Company Rehearing stated:  “The Decision
held that SFPP should be allowed to include the $ 5.4
million ‘tax allowance’ in its expenses for ratemaking purposes to prevent this
result.  This ‘tax allowance’ was
calculated using the corporate tax rate. 
Although there is logic to this approach, the Decision improperly
concludes that this approach must be adopted in order to comply with an
established ‘tax allowance policy.’  The
Decision incorrectly reads Application of SFPP, L.P.
(Increased Transportation Rates) [D.92-05-018], supra, to establish such a policy. 
When we approved SFPP’s 9% rate increase in
1992, we accepted a rate of return calculation that included an expense item
for taxes in the amount of $ 6,281,000. 
At the time, SFPP was a master limited
partnership that owned SFPP’s two predecessor
pipelines.  However, Application of SFPP, L.P. (Increased Transportation Rates), [D.92-05-018], >supra, was decided on an ex parte
basis and contains no discussion of tax questions.  Thus, no conclusion can be drawn from its
determination that the total expense amount was reasonable.  We generally do not scrutinize applications
that are not contested, and have stated this policy explicitly in Re:  Commission’s Rules of Practice and Procedure
[D.95-01-015] (1995) 58 Cal.P.U.C.2d. 480.” 
(ARCO Prods. Company Rehearing,> supra, 1999 Cal.P.U.C. Lexis 442, at
pp. *12-13.)  

                        Thus,
although the PUC believed “the use of a tax allowance is likely to be
permissible” the justification set forth in the 1998 case did not withstand
scrutiny.  (ARCO Prods. Company Rehearing, supra,
1999 Cal.P.U.C. Lexis 442 at p. *13) 
Rehearing was granted to consider tax issues and other matters.  (Ibid.)  Evidentiary hearings were held in October
2000, but the PUC then left the matter undecided until SFPP I.  (SFPP I, supra, 2011 Cal.P.U.C.
Lexis 299 at p. *1 [noting the Decision closes C.97-04-025, the Shippers’ 1997
complaint].) 

                        In
2001, SFPP proposed a surcharge to offset increases in power costs.  The request was approved, but the PUC
directed SFPP to file an application to justify its current rates.  The Decisions at issue here address both the
income tax allowance issue raised by the Shippers’ 1997 complaint and the
general rate application that SFPP filed at the PUC’s direction.

                        The
PUC issued SFPP I in May 2011.  (SFPP I, supra, 2011 Cal.P.U.C. Lexis
299 at p. 1.)  As relevant here, the PUC
decided that because SFPP is a partnership that pays no income taxes, it is not
entitled to an offset for income tax expenses. 
(SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at pp.
*18-37.)  It also approved a return on
rate base of 10.40 percent, which included a return on equity of 12.61
percent.  (Id., 2011 Cal.P.U.C.
Lexis 299 at p. *48.)  With respect to
these issues, SFPP II denied SFPP’s request for rehearing, although it
was granted as to certain other issues not pertinent here.  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *4.) 

III

DISCUSSION

A. Review of PUC Decisions

                        “‘[A]ny
aggrieved party [to a decision of the Commission] may petition for a writ of
review in the court of appeal . . . .’ 
[Citation.]  As here, when ‘writ
review is the exclusive means of appellate review of a final order or judgment,
an appellate court may not deny an apparently meritorious writ petition, timely
presented in a formally and procedurally sufficient manner, merely because, for
example, the petition presents no important issue of law because the court
considers the case less worthy of its attention than other matters.’  [Citation.] 
We are not, however, ‘compelled to issue the writ if the [Commission]
did not err . . . .  [Citation.]”  (Pacific Bell Wireless, LLC v.
Public Utilities Com.  (2006) 140
Cal.App.4th 718, 728-729 (Pacific Bell
Wireless).)

                        The
limited grounds and standards for our review are set forth in section 1757, subdivision (a).  “No new or additional evidence shall be
introduced upon review by the court.  In
a complaint or enforcement proceeding, or in a ratemaking or licensing decision
of specific application that is addressed to particular parties, the review by
the court shall not extend further than to determine, on the basis of the
entire record which shall be certified by the commission, whether any of the
following occurred:  [¶] (1) The
commission acted without, or in excess of, its powers or jurisdiction.  (2) The commission has not proceeded
in the manner required by law.  (3) The decision of the commission is
not supported by the findings.  (4) The findings in the decision of
the commission are not supported by substantial evidence in light of the whole
record.  (5) The order or decision of the
commission was procured by fraud or was an abuse of discretion.  (6)
The order or decision of the commission violates any right of the petitioner
under the Constitution of the United States or the California Constitution.”  Further, we cannot “hold a trial de novo, to
take evidence other than as specified by the California Rules of Court, or to
exercise [our] independent judgment on the evidence.”  (§ 1757, subd. (b).)

                        “There
is a strong presumption favoring the validity of a Commission decision.  [Citations.]” 
(Toward Utility Rate Normalization
v. Public Utilities Com. (1978) 22 Cal.3d 529, 537; see also >City and County of San Francisco v. Public
Utilities Com.  (1985) 39 Cal.3d 523,
530.)  “Generally, we give presumptive value to a public agency’s
interpretation of a statute within its administrative jurisdiction because the
agency may have ‘special familiarity with satellite legal and regulatory
issues,’ leading to expertise expressed in its interpretation of the statute.  [Citation.] 
Therefore, ‘the PUC’s “interpretation of the Public Utilities Code
should not be disturbed unless it fails to bear a reasonable relation to
statutory purposes and language. . . .” 
[Citation.]  However . . . the
interpretation of statutes is a question of law subject to independent judicial
review.  [Citation.]’  [Citation.]” 
(Pacific Bell Wireless,> supra, 140 Cal.App.4th at p. 729.)

                        To the
extent section 1757, subdivision
(a)(4) is at issue, we use familiar principles to review for substantial
evidence.  When an administrative
agency’s evidentiary findings are at issue, “The court must
consider all relevant evidence in the record, but ‘“[i]t is for the agency to
weigh the preponderance of conflicting evidence [citation].  Courts may reverse an agency’s decision only
if, based on the evidence before the agency, a reasonable person could not
reach the conclusion reached by the agency.”’ 
[Citation.]”  (>Eden Hospital Dist. v. Belshé (1998) 65
Cal.App.4th 908, 915.) 

                        When constitutional issues
are raised, we exercise independent judgment on the law and facts.  (§ 1760.) 
Nonetheless, we may not substitute our own judgment “as to the weight to
be accorded evidence before the Commission or the purely factual findings made
by it.  [Citations.]”  (Goldin
v. Public Utilities Commission (1979) 23 Cal.3d 638, 653.)

>B. 
Income Tax Allowance

                        SFPP asserts the PUC
“violated applicable law, abused its discretion, and deprived SFPP of due
process” by denying it an allowance for income taxes.  SFPP therefore claims the PUC’s decision on
this point is subject to review under section 1757, subdivision (a)(2)-(5).  The PUC responds by pointing out that SFPP is
a limited partnership, and as such, pays no income taxes.  Therefore, SFPP is not entitled to an allowance
for taxes it does not pay.  

                        We
briefly review the underlying basis for this dispute.  The Internal Revenue Code (IRC) treats
corporationshref="#_ftn3" name="_ftnref3"
title="">[3] and partnerships
differently for tax purposes.  Generally,
corporations must pay tax “for each taxable year on the taxable income” of the
corporation.  (26 U.S.C. § 11(a).)  In addition to the income tax paid by a
corporation, taxes are also typically paid by shareholders who receive earnings
distributions or dividends from corporate income.  (26 U.S.C. § 301,(a), (c); see >SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *20.) 
Partnerships, however, “shall not be subject to the income tax imposed
by this chapter.  Persons carrying
on business as partners shall be liable for income tax only in their separate
or individual capacities.”  (26 U.S.C. §
701.)  For tax purposes, a partnership is
“merely an agent or conduit through which the income passed.”  (United
States v. Basye (1973) 410 U.S. 441, 448, fn. omitted.) 

                        Thus,
SFPP, as a partnership, does not pay income taxes.  One of its witnesses testified on this point
before the PUC.  Rather, its upstream
partners (various Kinder Morgan entities, for the most part) are allocated
SFPP’s income and treated as if they had generated it directly. 

 

 

 

                        The
PUC’s practice is to calculate income tax allowances on a stand-alone basis,
without reference to corporate relationships such as holding companies,
affiliates, or subsidiaries.  (>SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *22.) 
This policy developed due to the increasing structural complexity of
regulated utility entities and the expansion of non-utility activities by
subsidiaries.  (Id., 2011
Cal.P.U.C. Lexis 299 at pp. *22-23.)  “Without the stand-alone treatment of the
regulated entity, the non-utility activities could result in a tax expense or
savings unrelated to the costs of providing utility service.”  (Id.,
2011 Cal.P.U.C. Lexis 299 at p. *24.)  Thus, the PUC looks to the tax liability of
the utility alone in calculating any allowance. 


                        As
the PUC readily admits, utilities established as corporations, which pay taxes,
are entitled to receive an appropriate allowance to cover the tax expense.  The Final Decision stated:  “SFPP
should receive an appropriate allowance for income tax expense, if it is liable
for income tax. . . .  SFPP has failed to
demonstrate that there is a corporate tax liability that should be recovered in
rates.  [¶] We only provide an allowance
where the utility expects to incur an expense. 
If, for example, SFPP were suddenly able to conduct business entirely
without paper, solely using electronic communications, there would no longer be
a need to purchase paper, ink, pens, postage, storage boxes, file cabinets,
etc.  No one would reasonably argue that
SFPP should still have a theoretical allowance for paper and pens, and related
items included in its expense forecast. 
If there is no likely expense, there should be no expense forecast in
rates.  [¶] [I]f there is no taxation on
earnings while the earnings are still within the operating control of SFPP,
there is no income tax obligation to recognize as a utility operating expense
in rates.”  (SFPP I, supra, 2011
Cal.P.U.C. Lexis 299 at pp. *27-28, fn. omitted.)

                        At
its essence, SFPP’s argument boils down to its claim that an income tax allowance
is required as a matter of law, while the PUC and the Shippers assert that it
was a policy choice made after an appropriate process.  We address the components of this argument
below.href="#_ftn4" name="_ftnref4"
title="">[4] 

 

                        1.  The PUC’s prior
decision

                        SFPP asserts the PUC’s
“own established income tax doctrine” requires it to grant partnerships an
income tax allowance.  SFPP relies
heavily on a decision involving it that we mentioned earlier, ARCO
Prods. Company,
supra,
1998
Cal.P.U.C. Lexis 593 at page *45.  In
that case, the PUC rejected the Shippers’ complaint that an income tax
allowance was inappropriate for a limited partnership, noting the ex parte
ratesetting in 1992 was adopted “in full recognition that defendant
was organized as a limited partnership.” 
(Ibid.)  SFPP claims the
Decisions represent an “about-face” without adequate justification.  SFPP completely ignores the 1999 decision on
rehearing, ARCO Prods. Company Rehearing, supra, 1999 Cal.P.U.C. Lexis 442
at page *12.  

                        The 1999
rehearing decision concluded that while there was logic in the approach the PUC
had taken in ARCO Prods.
Company, the justification did not withstand scrutiny.  (ARCO Prods. Company Rehearing, supra, 1999 Cal.P.U.C. Lexis 442 at
pp. *12-13.)  Further, the PUC stated it
needed “to consider the issue more carefully” because it had no established
policy in this area.  (Ibid.)  Rehearing prevented the original decision
from ever becoming final.  (>City of Los Angeles v. Public Utilities Com.
(1975) 15 Cal.3d 680, 707.)  Thus, the
Decisions do not represent a sudden departure from over a decade of precedent,
as SFPP suggests.  The PUC had already
rejected its 1998 rationale in 1999.

 

                        2.  Competing authorities

                        SFPP
correctly states that the Federal Energy Regulatory Commission (FERC) and some
state jurisdictions grant partnerships an income tax allowance on the grounds
that the tax paid by the partners is an operating cost.  (See Policy Statement on Income Tax
Allowances (2005) 111 F.E.R.C. P61,139, 2005 FERC Lexis 1129; Suburban
Utility Corp. v. Public Utility Com. (Tex. 1983) 652 S.W.2d 358; Moyston
v. New Mexico Pub. Serv. Comm’n. (N.M. 1966) 412 P.2d 840; Home
Tel. Co. v. State Corp. Comm’n. (2003) 31 Kan.App.2d 1002; Washington
Utilities & Transp. Com’n. v. Rainier View Water Co. (July 12, 2002) 2002 Wash. UTC Lexis 323; In re Detroit
Thermal, LLC (Sept. 8, 2005) 2005
Mich. PSC Lexis 293; In the Matter of the
Commission’s Generic Evaluation of the Regulatory Impacts from the Use of
Non-Traditional Financing Arrangements by Water Utilities and Their Affiliates
(Feb. 21, 2013) 2013 Ariz. P.U.C. Lexis 58.)

                        We
note, however, that a number of other jurisdictions have not permitted income
tax allowances for pass-through entities in the recent past.  (See South Haven Waterworks, Div. v. Office of Utility Consumer Counselor (Ind.Ct.App. 1993) 621 N.E.2d 653;href="#_ftn5" name="_ftnref5" title="">[5] Monarch Gas Co. v. Illinois. Commerce
Com. (51 Ill.App.3d 1977) 366 N.E.2d 945; Penn. Public Utility Com. v.
Jackson Sewer Corp. (Sept. 28, 2001) 2001 Pa. P.U.C. Lexis 53; Farmton
Water Resources LLC (Oct. 8, 2004) 2004 Fla. P.U.C. Lexis 863; Ridgelea Inv., Inc. (Oct. 14, 2008) 2008
Ky. P.U.C. Lexis 1259; Concord
Steam Corp. (Nov. 16, 1986, Order No. 18,484) 71 N.H. P.U.C. 667.) 

                        We need not delve into
the competing rationales at play here. 
Our only concern is whether the PUC’s decision violated the law in some
way which requires this court to step in. 
(§ 1757.)  Our review of these
cases demonstrate competing policy interpretations, but not, in contrast
to SFPP’s argument, a legally compelled result in any particular
direction.  Indeed, upon review of FERC’s
decision to permit income tax allowances to partnerships, the D.C. Circuit
described the decision as including “troubling elements,” yet deferred to FERC
as a matter of policy.  (ExxonMobil
Oil Corp. v. F.E.R.C. (D.C. Cir. 2007) 487 F.3d 945, 948.)  “[P]olicy choices about ratemaking are the responsibility of the Commission—not this
Court.  [Citation.]”  (Id.
at p. 953.)

                        Further, the fact that
some states made their decisions before FERC’s policy statement is not of
particular import, as SFPP does not argue federal preemption.  While SFPP’s side of this argument may have
more jurisdictions behind it at this point in time, that is not particularly
relevant, as policy decisions left to individual states are not subject to a
popularity contest.

                        SFPP has
not demonstrated the law requires the PUC to grant partnerships an income tax
allowance, nor do we agree that the SFPP “arbitrarily” failed to address FERC’s
reasoning.  The Decisions reflect the PUC
was clearly aware of FERC’s different policy choice on this point, and thus,
the record does not support SFPP’s claim the PUC arbitrarily and capriciously
refused to consider FERC’s reasoning. 
Given that SFPP vehemently disagrees, its remedy is with the
legislature, and not, given our limited scope of review, with this court.

 

                        3.  The PUC’s understanding of the relevant law

                        SFPP
argues the PUC’s decision was based on an erroneous view of the law, lacked
substantial evidence, and should therefore be vacated pursuant to section
1757.  SFPP claims the decision “rests
entirely on findings that are wrong as a matter of governing federal tax
law.”  SFPP claims the PUC incorrectly
concluded that the partners incurred a personal income tax obligation only
after the partnership distribution, which it argues is untrue.  Further, any income tax obligation accrues
while the income is still in control of the partnership.

                        Contrary to SFPP’s
claims, the Final Decision reflects the PUC was aware of the relevant income
tax obligations.  “SFPP itself does not directly pay tax on the
income it generates because SFPP is organized as a limited partnership.  However, this does not mean that income
generated by SFPP is necessarily tax-free. 
SFPP’s income could be eventually taxable in the hands of SFPP’s
upstream owners, regardless of the amount of cash SFPP actually distributes to
them.  The amount of tax paid on income
SFPP generates depends on the tax situation of each of its owners—including the
possibility that the tax obligation may be passed on to a further, indirect
owner of SFPP.”  (>SFPP I, supra, 2011 Cal.P.U.C. Lexis 299 at p. *19.)  In
the Rehearing Decision, the PUC repeated: 
“The Decision clearly
shows that we did understand that SFPP’s partners are responsible for any tax
on its earnings.”  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *7.)  Rather, the PUC rejected SFPP’s preferred
method of treating the partnership as the tax-paying entity for purposes of
setting rates.  (Ibid.) 

                        SFPP also argues that
the stand alone doctrine, which, as we previously noted, treats utilities as
separate from any affiliates for ratemaking purposes, compels the PUC to grant
partnerships an income tax allowance. 
Arguing that the PUC has granted allowances to corporations even if
their parent pays taxes as part of a consolidated return, SFPP argues this is
no different from the tax a partner pays on SFPP’s income.  As the PUC accurately explains, however, this
ignores that a corporate utility and its parent each have a separate income tax
liability.  Thus, while a parent may pay
the tax on a consolidated return, the utility is still responsible for the tax
separately.  That is not true of a
partnership.  We therefore disagree that
the stand alone doctrine requires partnership income tax allowances.

                        SFPP has not established
that the PUC used “legally erroneous principles,” in denying an income tax
allowance; it would simply prefer a different policy.href="#_ftn6" name="_ftnref6" title="">[6]  Indeed, the Decisions show the PUC fully
understood the relevant principles of federal tax law, and applied two
long-standing policies.  First, as noted
above, the PUC calculates income tax allowances on a stand-alone basis, without
regard to other related entities.  (SFPP I,> supra, 2011 Cal.P.U.C. Lexis 299 at p.
*22.)  Second, to protect ratepayers, only
legitimate, actual expenses incurred by the utility are recognized as part of
the ratemaking process.  (City and
County of San Francisco v. Public Utilities Com. (1971) 6 Cal.3d 119,
129.)  The PUC applied both of these
principles in reaching its decision.

                        Similarly, we reject
SFPP’s argument that the PUC abused its discretion and based its decision on a
misunderstanding of the economic consequences of denying an income tax
allowance to partnerships.  To the extent
SFPP’s argument on this point is not conclusory, no “misunderstanding” is
supported by the record. 

 

                        >4. 
Due Process

                        SFPP
also contends it was denied a reasonable opportunity to develop an evidentiary
record on its actual or potential liability, and was therefore denied due
process.  Specifically, it claims the PUC
predicated its decision on an evidentiary standard that did not exist until the
Final Decision.  This standard, also
known as the “FERC test,” refers to FERC’s requirement, established in its 2005
Policy Statement on Income Tax
Allowances, requiring partnerships to provide evidence of evidence of actual

 

or potential taxes in order to calculate an
income tax allowance, rather than relying on the corporate tax rate. 

                        While
SFPP claims the PUC “endorse[d]” the FERC test, this is a confusing assertion,
given the PUC explicitly rejected the underlying policy that made the FERC test
relevant.  As far as the PUC is
concerned, the only “actual or potential” tax liability that matters is federal
income tax liability at the organizational level, of which SFPP, as a
partnership, has none.  (26 U.S.C. §
701.)  SFPP appears to be engaging in an
out-of-context reading of the Decisions to support this argument.  For example, the Final Decision mentions that
“SFPP would fail the current FERC test
on the record in this proceeding,” (SFPP
I, supra, 2011 Cal.P.U.C. Lexis
299 at p. *35) but that was not the basis for the PUC’s decision.  Rather, the Final Decision explicitly
rejected the adoption of FERC’s rule with regard to tax allowances for
partnerships, noting:  “In this instance, we do not need our
ratemaking determinations to match with FERC’s ratemaking, because this
Commission must also act within the scope of its discretion, and act reasonably
on its record.”  (Id., 2011 Cal.P.U.C. Lexis 299 at p. *37.)  Instead, it concluded:  “We find that SFPP does not have ‘an actual
or potential income tax obligation on the entity’s public utility income’ in
addition to the personal tax obligation of the partners after the partnership
distribution.”  (Ibid.) 

                        On
rehearing, the PUC made clear that policy, not a lack of evidence, compelled
its decision:  “Because SFPP pays no
income tax itself, the Decision found it was not entitled to an income tax
allowance for ratemaking purposes.”  (SFPP
II,
supra, 2012 Cal.P.U.C. Lexis 135 at p. *6, fn. omitted.)  “The
Decision clearly shows that we did understand that SFPP’s partners are
responsible for any tax on its earnings. 
What we rejected was SFPP’s suggestion that SFPP and its partners are
one and the same.  Partnerships are
viewed as ‘independently recognizable entities apart from the aggregate of
their partners’ for income tax purposes.” 
(Id., 2012 Cal.P.U.C. Lexis
135 at p. *7, fns. omitted.)  Thus,
given the PUC rejected the policy on which SFPP’s claimed assertion for new
evidence is based, its due process claim lacks merit.href="#_ftn7" name="_ftnref7" title="">[7]

 

C.  Return on Equity

                        SFPP
next argues the PUC abused its discretion by setting an unreasonably low rate
of return on equity based on incorrect legal standards.  While SFPP wanted a return on equity of 15.86
percent, the PUC adopted a rate of 12.61 percent.  The Shippers recommended a rate of 12.28
percent.  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *18.)

                        We
begin by reviewing the relevant ratemaking principles.  It is well-settled that a utility is entitled
to a reasonable return on its rate base, that is, “the value of the property
which it employs for the convenience of the public . . . .”  (Bluefield
Water Works & Improvement Co. v. Public Serv. Comm’n. (1923) 262 U.S.
679, 692.)  A reasonable return is one
which is “generally being made at the same time and in the same general part of
the country on investments in other business undertakings which are attended by
corresponding risks and uncertainties; but [the utility] has no constitutional
right to profits such as are realized or anticipated in highly profitable
enterprises or speculative ventures.”  (>Id. at pp. 692-693.)  While the return on equity “should be
sufficient to provide a margin of safety for payment of interest and preferred
dividends, to pay a reasonable common dividend, and to allow for some money to
be kept in the business as retained earnings,” the PUC “must set the ROE at the
lowest level that meets the test of reasonableness.”  (Application
of Pacific Gas and Electric Company (Cal.P.U.C. Nov. 7, 2002) 221 P.U.R.4th
501, 510 [2002 Cal.P.U.C. Lexis 718 at p. *27] (PG&E); see also In Re
Application of Pacific Gas and Electric Company (Cal.P.U.C. Nov. 23, 1992)
46 Cal.P.U.C.2d 798 [1992 Cal.P.U.C. Lexis 798 at p. *161].)

                        “The
Commission examines several cost components in calculating a utility company’s
revenue requirement.  The Commission
begins by determining the value of the assets that the company has invested in
to provide utility service . . . .  This figure is known as the ‘rate
base.’”  (The Ponderosa Telephone Co. v. Public Utilities Com. (2011) 197
Cal.App.4th 48, 51 (Ponderosa).)  “To invest in rate base assets, a utility
company raises funds by either issuing debt or selling equity.  Costs are associated with each method.  The company either has to pay interest to
creditors on borrowed funds or pay a portion of profits or dividends to equity
investors, i.e., shareholders.  This cost
is known as the cost of capital.  The
cost of capital, also known as the rate of return, multiplied by the rate base
is one component of the utility company’s revenue requirement.”  (Ibid.)  In most instances, a mix of debt financing
and equity is used.  (>Ibid.) 


                        “The
Commission determines a utility company’s cost of capital in a three-step
process.  The Commission first adopts a
reasonable capital structure, i.e., the proportion of debt to equity that a
utility company should use to finance its capital
needs.  Next, the Commission calculates
the company’s cost of debt, based on the actual cost of the company’s
outstanding debt during the most recent period. 
Third, the Commission determines the appropriate return on the equity
component of the utility company’s capital by examining returns for businesses
with comparable risks.  Applying the
resulting figures to the adopted capital structure produces the weighted cost
of capital.  This weighted cost of capital
becomes the utility company’s authorized rate of return on rate base.”  (Ponderosa,> supra, 197 Cal.App.4th at pp. 51-52.) 
Finally, “the Commission determines the utility company’s rate base and
multiplies that number by the authorized rate of return.  This figure is then added to the company’s
operating expenses and tax costs.  The
sum is the company’s revenue requirement, i.e., the amount needed to cover the
company’s costs and provide a reasonable return on its investments.”  (Id.
at p. 52.)

                        In
order to determine the numbers that go into the PUC’s analysis, several  financial models are used as a starting
point.  One of these is the discounted
cash flow (DCF) analysis.  (>PG&E, supra, 2002 Cal.P.U.C. Lexis 718 at pp. *24-25.)  Although the models themselves are
subjective, the results depend on subjective inputs, which result in a wide
range of recommend returns.  (>Ibid; see also Application of California Water Service Company (Cal.P.U.C. 2009)
272 P.U.R.4th 512, 524 [2009 Cal.P.U.C. Lexis 233 at p. *36].)  “In the final analysis, it is the application of informed judgment, not the precision of financial
models, which is the key to selecting a specific ROE estimate.  [A]s we have routinely stated in past
decisions, the models should not be used rigidly or as definitive proxies for
the determination of the investor-required return on equity.  Consistent with that skepticism, we find no
reason to adopt the financial modeling of any one party.  The models are only helpful as rough gauges
of the range of reasonable outcomes.”  (>Ibid.)

                        According to> SFPP I, the PUC adopted SFPP’s proposed
capital structure of 60 percent equity and 40 percent debt.  (SFPP I,> supra, 2011 Cal.P.U.C. Lexis 299 at p.
*48.)  It also determined the cost of
debt was 7.08 percent.  (>Ibid.) 
The PUC concluded that “it is
within our discretion, and within the recommended range, to adopt a return of
12.61% on equity, which yields a weighted cost of capital for test year 2003 of
10.40%.  The equity return is
significantly higher than the rate adopted for the major energy distribution
utilities, and is slightly higher than the recommendation of intervenors.  When viewed with the 60% equity ratio, this
return should be a sufficient to compensate investors for the operating
and financial risks associated with SFPP’s operations.”  (Id.,
2011 Cal.P.U.C. Lexis 299 at pp. *48-49.) 


                        The
Final Decision also reflects that the return on investment recommended by SFPP
and the Shippers differed significantly, based on the financial model
used.  (SFPP I, supra, 2011
Cal.P.U.C. Lexis 299 at p. *47.)  The PUC
noted the recommendations with approved returns on equity for four non-pipeline
utilities, using 2003 as a test period. 
(Id., 2011 P.U.C. Lexis 299 at
pp. *42-49.)  The compared returns on
equity ranged from 10.9 percent to 11.6 percent, returns lower than either SFPP
or the Shippers recommended.  (Id.,
2011 Cal.P.U.C. Lexis 299 at pp. *46-48.) 
The Final Decision noted significant differences between SFPP,
underscoring “the need to evaluate rate of return on a case-by-case
basis.”  (Id., 2011 Cal.P.U.C. Lexis 299 at p. 47.)  Using the parties’ models as a “starting
point” (SFPP
II,
supra, 2012 Cal.P.U.C. Lexis 135 at p. *19), the PUC then
“exercised our discretion to
make pragmatic adjustments to the recommended outcomes . . . .”  (Ibid.)


                        Essentially,
SFPP complains that the PUC did not use validly calculated recommended returns
on equity based on a valid proxy group with comparable risks.  First, it claims the PUC “erred in endorsing
the Shippers’ proposed ROE as a valid lower reference point, then closely
adhering to that figure.”  According to
SFPP, the Shippers’ proposal was based on “discounted income” rather than
“discounted cash flow.” 

                        There
is no evidence, however, that the PUC endorsed any specific
recommendation.  As the Rehearing
Decision stated:  “DCF analyses are merely one tool the
Commission uses as a starting point to estimate a fair ROE.  And all financial models have certain
flaws.  For that reason, they are not
rigidly applied or viewed as definitive proxies to determine ROE.  They are merely used to provide a rough gauge
of the range of reasonable outcomes.”  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at pp. *18-19, fn.
omitted.)  The fact that the return on
equity the PUC ultimately adopted was closer to the Shippers’ recommendation
than SFPP’s proves nothing. 

                        Nor
do we accept SFPP’s implication that there is only one acceptable DCF
methodology.  As the PUC points out, even
SFPP’s analysis used multiple variations. 
Further, the law does not “‘bind rate-making bodies to the
service of any single formula or combination of formulas.  Agencies to whom this legislative power has
been delegated are free, within the ambit of their statutory authority, to make
the pragmatic adjustments which may be called for by particular circumstances.
. . .’  [Citations.]”  (City
of Los Angeles v. Public Utilities Com.,
supra, 15 Cal.3d at p. 698.)  We must therefore reject SFPP’s argument on
this point.

                        Second,
with respect to the appropriateness of the proxy group, SFPP contends the PUC
either used an inappropriate group or none at all.  As noted above, utilities are usually
entitled to earn a return similar to those of other companies having similar
business risks.  (Bluefield Water Works & Improvement Co. v. Public Serv. Comm’n.,> supra, 262 U.S. at pp. 690, 692.)  Companies used for such comparisons are
referred to as proxy groups.  SFPP argues
the PUC either considered an inappropriate proxy group or none at all.

                        The
record does not support this conclusion. 
With respect to the claim the PUC used an inappropriate comparison group
of non-pipeline utilities, the Rehearing Decision clarifies that is not what
occurred.  “SFPP is wrong that the Decision relied on a proxy group of energy
utilities for purposes of the ROE analysis. We did generally note the
authorized ROEs for Pacific Gas and Electric Company, Southern California
Edison Company, San Diego Gas & Electric Company, and Sierra Pacific Power
Company during the same 2003 time frame. 
However, we specifically stated that the differences between SFPP and
energy utilities required that we evaluate authorized returns on a case-by-case
basis.”  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *16, fns. omitted.)  Thus, SFPP’s argument that these companies
were used as a proxy group is incorrect.

                        If
that is not the case, SFPP claims, then the PUC used no proxy group at all,
which is equally problematic.  But this,
too, is unsupported by the record.  Both
SFPP and the Shippers agree they used the same proxy group of five publicly
traded oil pipelines in their own DCF analyses. 
As the Rehearing Decision noted, the PUC “reviewed the DCF analyses presented by both parties . . . .”  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *19.)  Thus, the Shippers argue, and we agree, the
PUC necessarily considered this group “to provide a rough gauge of the range of reasonable outcomes.”  (Ibid.,
fn. omitted.)  We must therefore reject
SFPP’s contention that the PUC relied on no proxy group at all.  The fact that the PUC did not discuss the
proxy groups at length is not evidence it did not consider them.

                        Further,
as the PUC stated, “It is also relevant to note that this Commission regulates
very few oil pipeline companies that we can look to for comparison
purposes.”  (SFPP II, supra, 2012 Cal.P.U.C. Lexis 135 at p. *16.)  While SFPP criticizes this statement and
urges the PUC to draw from “public information” about other pipelines in what
it considers to be a valid proxy group, there is no legal requirement for the
PUC to do so.  As the PUC points out,
“Nothing in the record provided a meaningful factual comparison or analysis of
the relative risks and uncertainties of those entities.” 

                        Finally, a
proxy group is just one element of many the PUC considers in setting
rates.  There is no support in the record
that the PUC abused its discretion in doing so here.

IV

DISPOSITION

                        The
petition for writ of review is denied. 
Respondent and real parties in interest are entitled to their href="http://www.fearnotlaw.com/">costs on appeal.

 

 

                                                                                   

                                                                                    MOORE,
ACTING P. J.

 

WE CONCUR:

 

 

 

ARONSON, J.

 

 

 

THOMPSON, J.