Residential Utility Consumer Office v. Arizona Corporation Commission (8/18/2015)

September 3, 2015

Arizona Court of Appeals Division One holds that the Corporation Commission’s approval of utility rate surcharges to recoup capital expenditures made between rate cases is unconstitutional.

A primary task of the Arizona Corporation Commission is to regulate the rates that public service corporations such as water or electric utility companies can charge.  A water utility sought approval from the ACC to charge a “distributed system improvement charge,” a rate surcharge that would allow the utility to recoup certain capital costs for specific capital improvement projects completed before the utility’s next rate case.  After a series of proceedings, the ACC approved a form of the system improvement charges. The Residential Utility Consumer Office (“RUCO”), a state agency that represents interests of utility consumers in ACC proceedings, opposed the surcharge proposals and appealed the ACC’s decision.

The Arizona Constitution gives the ACC “full power” to set “just and reasonable rates and charges to be made and collected” by public service corporations. Ariz. Const. art. 15, § 3.  In setting rates, the ACC must “ascertain the fair value of property.”  On appeal, RUCO argued that the approved system improvement charges are unconstitutional because the charges violate the requirement that the ACC determine the fair value of the utility’s property when setting rates.

The Court of Appeals agreed with RUCO and held that the surcharges are unconstitutional.  The ACC “cannot impose a rate surcharge based on a specific cost without first determining a utility’s fair value rate base.”  The determination is to be made “at the time of inquiry.”  Although the specific surcharges would be subject to ACC approval, they would not require the same amount of documentation and would not be subject to “a full fair value determination.”  Instead, the surcharge approval focused only on “marginal effect” of the surcharge on fair value based on the previous cycle’s full fair value determination.  Given that the surcharge approval could occur as much as five years after the previous determination, that assessment failed to satisfy the ACC’s obligation to determine fair value “at the time of inquiry.” 

The Court also held that the surcharges “differ[ed] materially” from the “step rate increases” discussed in Arizona Community Action Association v. Arizona Corporation Commission, 123 Ariz. 228 (1979).  In that case, the Arizona Supreme Court said (in dicta, according to the Court of Appeals) that the ACC “may consider construction work in progress in calculating a utility’s fair value and may approve prospective percentage rate increases based on that fair value for a limited period of time.”  Here, in contrast, the Court explained that the surcharges were approved for capital work that was not yet in progress, additional projects could be added, and the ACC authorized surcharges going for up to five years—the whole length of time between rate cases—rather than a “limited period of time.”

The Court also held that the system improvement charge mechanism does not qualify for one of the two narrow exceptions to the fair-value requirement.  First, the system improvement charges did not qualify as “automatic adjustor” charges because they were rate increases linked to certain capital expenditures, not amounts that fluctuated up and down with an operating expense such as the wholesale cost of a commodity input.  Second, the surcharges are not “interim rate” increases because “interim rates” are only exempt from the fair-value requirement if, among other things, “an emergency exists.”  Although evidence showed that the utility needed to replace or improve much of its infrastructure to a greater extent than in the past, the record did not show an emergency; the utility was not “ambushed” with unforeseen capital needs for its aging infrastructure.

Judge Downie authored the unanimous opinion; Judges Jones and Thompson concurred.