A California court of appeals recently held that utility companies operating in rural areas of the state do not collect a higher cost of capital, also referred to as a rate of return, than other utility companies.
In Ponderosa Telephone Co. v. California Public Utilities Commission, several small, rural, privately-owned telephone companies asked the California court of appeals to review a decision of the California Public Utilities Commission (“PUC”).[1] The PUC’s ruling related to the companies’ cost of capital, “a measurement of the cost of obtaining debt and equity financing, and it reflects the amount investors would demand to compensate them for the risks of investing capital in the company.”[2] This is also referred to as the rate of return, as it provides the target return on the utility’s capital.[3] The number is a factor in determining a company’s rate base and is calculated by examining (1) the cost of debt, (2) the cost of equity, and (3) the capital structure.[4]
The companies filed a petition to the PUC proposing that their rates of return be reviewed and altered to approximately 14.6%. The proposed amount represented a significant increase from the previous figure of 10% and reflected special risk factors the companies faced, including their small size, industry risks, and regulatory risks.[5] However, following its review, the PUC denied the companies’ requests and lowered their rates of return to approximately 9%. The companies sought a review of the ruling, arguing that the PUC’s conclusion was arbitrary and capricious, and was unsupported by substantial evidence.[6]
The Court of Appeals for the State of California upheld the PUC’s decision. To overturn its decision, the Court needed to find the PUC’s calculation process was unreasonable or unsupported by the record’s evidence. As such, the Court examined the PUC’s analysis for each of the three risk factors presented. Despite the companies citing their relative size as a potential risk, both the PUC and the Court noted that the companies had averaged a 9.4% rate of return over the past five years without difficulty. Regarding the proposed industry risk, the Court agreed with the PUC that the companies had failed to justify a sufficient basis for their claims. Finally, while regulatory risks do exist, California already addresses this risk by offering subsidies to eligible phone companies providing service to rural and remote areas. Because a reasonable person could examine this record and deny the companies’ petition, the Court affirmed the PUC’s decision.
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[1] Ponderosa Telephone Co. v. California Public Utilities Commission, F076845 (2019).
[2] Id. at 4.
[3] Id.
[4] Id. at 6.
[5] Id. at 7-9.
[6] Id. at 13. The companies also argued that the PUC ruling violated their constitutional right to due process, as the rates were so unjust as to qualify as a “taking.” However, given their findings on the “arbitrary and capricious” argument, the Court ruled that the process were not unjust.
Jeremy Fetty is a partner in the law firm of Parr Richey with offices in Indianapolis and Lebanon. Mr. Fetty is current Chair of the Firm Utility and Business Section and often advises businesses and utilities (for profit, non-profit and cooperative) on regulatory, compliance, and transactional matters.
The statements contained herein are matters of opinion and general information only and are not to be considered legal advice and should not be construed to form an attorney-client relationship. If you have any questions regarding this article, please contact an attorney.