Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

A Brief History of Rate Base: Necessary Foundation or Regulatory Misfit?

Regulators today must define earnings for energy retailers virtually bereft of fixed assets.

Fortnightly Magazine - July 2006

to “the taking of private property for public use without just compensation.”

The court further stated that in ascertaining what would constitute just compensation, the interests of both shareholders and consumers must be considered. This balancing cannot be accomplished, according to the court, without considering the “fair value of the property used for the public, or the fair value of the services rendered.” Thus, the “basis of all calculations as to the reasonableness of the rates to be charged … must be the fair value of the property being used by it for the convenience of the public.”

The key aspect of this decision is that a company is entitled to a fair return on the value of the property employed for the public convenience, and the public is entitled to demand that it pay no more than the reasonable worth of the services received. Smyth established a “law of the land” whereby “value” and its equivalent “fair value” formed the cornerstone of utility, pipeline, telecommunication, and transportation rate-making. Thus,  Smyth created a rather elaborate approach for establishing fair returns based on value, one whose basic concepts remain embedded in modern day cost-of-service regulation.

While the standard of “fair value” was worthy, most practitioners and courts in the United States eventually found the standard to be ambiguous and confusing in practice. Modern regulation in the United States is the result of various Supreme Court decisions in the 1920s through the 1940s that have interpreted and revised  Smyth. During that regulatory era, vigorous debates were waged by those who favored fair value, replacement (or reproduction) cost, and original cost.

Regulation Post Federal Power Commission v. Hope Natural Gas

The Hope case represented a paradigm shift of major proportion in utility regulation. In that case, the Supreme Court found that the “end result” of a myriad of factors and judgment should be used to establish regulated tariffs and authorized returns.  Hope diluted the Smyth decision’s conceptual standard of value and left regulators to consider a combination of many factors, most of which were initially non-uniform. The  Hope decision left something of a conceptual void, which the various legal and regulatory findings that followed attempted to fill. Many regulators, including the present-day Federal Energy Regulatory Commission (FERC) and its Federal Power Commission predecessors, began to search for a conceptual anchor to secure the judgments they made to alter, tweak, and adjust the formulas and accounting data used in rate-making. Into this void, original-cost rate base emerged as that anchor for most regulators. Rate base is an accounting tool to measure what was prudently invested, less depreciation. It is based on standards dictated by regulators, not tax collectors or financial reporting.

Although the concepts and purposes supporting the fair value concept remain valid, practitioners sought and eventually replaced Smyth’s vague fair-value standard with a more precise, albeit not necessarily more accurate, surrogate. That surrogate came to be called “prudent investment” and “original cost-of-service,” with the inherent benefit of being somewhat easier to quantify with a reasonable degree of objectivity than “fair value.” While relatively easy