State Ex Rel. Midwesst Gas Users'ass'n v. Public Service Com'n of State of Missouri

Citations: 976 S.W.2d 470; 1998 WL 549295Docket: WD 53811

Court: Missouri Court of Appeals; September 1, 1998; Missouri; State Appellate Court

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Relators Midwest Gas Users' Association and the Office of the Public Counsel appeal a Public Service Commission (PSC) decision that allowed Missouri Gas Energy (MGE) to implement a Purchased Gas Adjustment Clause (PGA) and an Actual Cost Adjustment (ACA) for natural gas rates. They argue that these mechanisms represent unlawful single-issue ratemaking and retroactive ratemaking, which are prohibited under Missouri law. The court finds that the PGA and related mechanisms do not violate these principles. 

Additionally, the Midwest Gas Users' Association contends that the PGA's allowance for MGE to pass 'take-or-pay' costs to its members is illegal since they do not purchase gas from MGE but only transport it. The PSC determined that both sales and transportation customers benefited from the deregulation of the natural gas sector, and thus it was reasonable to apply the PGA clause to all customers affected by these costs. The court affirms the PSC's decision, asserting it was supported by evidence and not arbitrary.

The case also outlines the regulatory framework of the natural gas industry, highlighting the roles of producers, transporters, and distributors, and the natural monopoly that pipelines hold due to economies of scale.

Many customers rely on a single pipeline for natural gas, leading to concerns about potential exploitation due to monopolistic practices. To mitigate this risk, the government began regulating the industry following the 1938 Natural Gas Act, which granted the Federal Power Commission (FPC) authority over interstate gas transportation and resale, while states regulated local distribution. The FPC also controlled prices charged by producers to transporters, allowing pipelines to adjust rates based on gas cost fluctuations via a purchased gas adjustment (PGA) clause.

By the late 1970s, dissatisfaction with existing price regulations led to the establishment of the Federal Energy Regulatory Commission (FERC) in 1977, replacing the FPC. The Natural Gas Policy Act of 1978 aimed to gradually deregulate producer prices amidst an energy crisis. Many pipelines, concerned about gas supply shortages, entered into long-term contracts containing 'take-or-pay' clauses, obligating them to purchase minimum gas quantities at potentially inflated prices. If they failed to take the contracted gas, they faced substantial penalties.

In the 1980s, to curb pipeline monopolies and anti-competitive conditions, FERC implemented measures to regulate gas sales and transport. Under Order No. 436 (1985), pipelines were restricted to transportation services, allowing customers to buy gas directly from suppliers instead of through the pipelines. This led to many former sales customers opting for direct purchases, leaving pipelines with fewer buyers while still bound to their costly 'take-or-pay' contracts. As a result, pipelines had to consider strategies to renegotiate or exit these contracts.

In 1992, FERC issued Order No. 636, requiring pipelines to 'unbundle' their sales and transportation services to eliminate market distortion caused by pipeline monopolies. This shift led to various transition costs for interstate pipelines, discussed in a related decision, State ex rel. Midwest Gas Users' Ass'n v. Public Service Comm'n. Under FERC-approved tariffs, pipelines passed gas costs to local distribution companies, such as MGE, via a Purchased Gas Adjustment (PGA) clause. The 'filed rate doctrine' prohibits states from preventing local distribution companies from passing these costs to customers, as established in Mississippi Power and Light Co. v. Mississippi ex rel. Moore and Nantahala Power and Light Co. v. Thornburg. However, state regulatory bodies retain authority over how local companies allocate costs and can assess the prudence of contract decisions when alternatives exist. 

Historically, before 1962, local distribution companies in Missouri adjusted rates through general rate proceedings in response to wholesale price changes. Following FERC's allowance for a PGA clause, Laclede Gas Company sought similar authorization from Missouri's PSC in 1962, establishing a mechanism for automatic rate adjustments based on wholesale cost changes. The PGA clause has evolved but retains its core function of enabling local distribution companies to adjust customer rates in line with wholesale supplier charges. Annually, companies file actual cost adjustment (ACA) requests with the PSC to verify the accuracy of previously estimated charges. In 1985, Missouri's PSC examined the impact of federal regulatory changes on local gas corporations, concluding that the PGA clause remained the most efficient method for recovering gas costs, while affirming intentions to further investigate deregulation effects in the future.

On October 19, 1989, the Missouri Public Service Commission (PSC) reaffirmed that the Purchased Gas Adjustment (PGA) clause is the appropriate mechanism for recovering purchased gas costs, allowing local distribution companies to pass take-or-pay costs from upstream suppliers to their customers through this clause, and explicitly stating that these costs cannot be recovered through separate tariff proceedings. In 1993, Western Resources, Inc. entered into a stipulation regarding its PGA clause in rate case GR-93-240, deferring related issues and setting a six-month deadline for PSC action. After Southern Union Company acquired most of Western Resources' assets in January 1994, its division, MGE, assumed Western's obligations and sought to address unresolved PGA issues, leading to the establishment of case GO-94-318 by the PSC on April 15, 1994.

The PSC segmented the unresolved issues into two phases, with only the Missouri Gas Energy Users Association (MGUA) appealing the Phase I determination. Phase II primarily examined whether to eliminate the PGA/ACA mechanism in favor of traditional rate case procedures for gas cost recovery, or to approve an experimental incentive mechanism proposed by MGE. Following an evidentiary hearing from November 6-8, 1995, the PSC issued a Report and Order on February 14, 1996, concluding that the PGA/ACA mechanism is effective for managing short-term gas price fluctuations and should not be eliminated, citing significant policy reasons for its retention to benefit both ratepayers and MGE.

The Commission determined that removing the PGA/ACA mechanism could lead to significant windfall profits for Missouri Gas Energy (MGE) at the expense of ratepayers or potentially jeopardize MGE's financial stability. Under Missouri law, the Commission must ensure that natural gas charges are just and reasonable, which current rates derived from the PGA/ACA mechanism are deemed to be. The Commission noted that a considerable part of gas costs remains regulated by FERC and that the PGA/ACA mechanism aligns with the nature of costs incurred by local distribution companies. It also acknowledged an ongoing transition in the natural gas sector towards competition, deeming the removal of the PGA/ACA mechanism inappropriate at this time. The feasibility of managing gas costs through traditional rate cases was questioned.

Additionally, the Commission approved an experimental gas cost incentive mechanism proposed by MGE, which sets a benchmark price for gas costs anticipated over the next year, allowing for certain adjustments based on actual costs relative to this benchmark. If actual costs fall within 4% above the benchmark, full recovery is permitted; between 4% and 10%, only 50% of the excess can be recovered; and above 10%, a prudence review is triggered. Conversely, if costs are below 94% of the benchmark, ratepayers receive 100% of the savings. This mechanism aims to incentivize MGE to minimize gas costs while reducing the regulatory burden on the Commission. The PSC found that this mechanism leverages competitive market dynamics and balances MGE's interests with those of ratepayers, officially permitting its implementation for a three-year experimental period. An application for rehearing by MGUA regarding the PSC's Phase II decision was denied.

MGUA and the Office of the Public Counsel filed Petitions for Writ of Review, leading to writs issued by the circuit court on March 26, 1996. Following a motion to consolidate appeals for Phase I and Phase II, the circuit court issued findings affirming the PSC's decision on December 3, 1996. Relators subsequently appealed. The appeals court reviews the PSC's decision, maintaining a presumption of validity, placing the burden of proof on those challenging it. The judicial review follows a two-part test: legality of the PSC's order, which must be statutorily authorized; and reasonableness, which requires substantial and competent evidence. The court will not substitute its judgment for the PSC's on factual issues.

The core contention is whether the use of a purchased gas adjustment (PGA) clause is permissible under Missouri law. Both Relators argue that the PGA clause is unauthorized as it allows single-issue ratemaking focused solely on gas costs, violates retroactive ratemaking principles by including past costs, and undermines the PSC's ratemaking authority by allowing utilities to set variable rates. However, the court finds these arguments without merit, noting that the key issue is whether Missouri statutes permit the PSC to use a PGA/ACA clause or an incentive mechanism for gas distribution companies, with both parties acknowledging the lack of explicit authorization in the statutes.

The legislature has acknowledged the Public Service Commission's (PSC) use of the Purchased Gas Adjustment (PGA) mechanism by exempting certain rate adjustment notices in Section 386.610, thereby implying approval of the PSC's authority to adjust rates outside a general rate proceeding. Chapter 386 establishes the PSC's regulatory framework over utilities, while Chapter 393 outlines the PSC's powers, allowing it broad discretion in rate regulation without being confined solely to general rate case procedures. 

The PSC is authorized to conduct hearings on utility rates either on its own initiative or in response to complaints, and utilities can propose new rates that automatically take effect unless suspended by the PSC. The commission can set maximum rates for gas, which must remain valid for a period not exceeding three years, and it may consider a wide range of relevant factors in its pricing determinations, not strictly limited to the allegations in complaints.

Key Missouri Supreme Court cases, such as Utility Consumers Council and Hotel Continental v. Burton, provide crucial interpretations of these regulatory principles, although there is disagreement between parties regarding their application. The case of Hotel Continental focused on the legality of a Tax Adjustment Clause, where the PSC permitted additional billing for specific taxes imposed by local authorities. The analysis of these cases will inform the evaluation of the PGA/ACA clause at issue in the current matter.

The utility collected taxes alongside regular charges and remitted them to the local taxing authority, with the PSC-approved rate schedule allowing automatic adjustments to the tax amount based on changes from the taxing authority. The PSC's rationale was that its authority to set just and reasonable rates permitted treating taxes as a distinct operating expense. The Missouri Supreme Court upheld this approach, rejecting claims that the tax adjustment clause (TAC) violated the filed rate doctrine, affirming that the utility merely passed through tax costs to consumers without altering overall rates or returns. In the subsequent case, Utility Consumers Council, electric utilities cited Hotel Continental to justify an automatic fuel adjustment clause (FAC) that allowed them to pass on fuel cost fluctuations to consumers. While some states have rejected FACs for conflicting with fixed rate structures, Missouri's PSC first adopted a FAC in 1974, subsequently modifying it in 1976. The PSC defended the FAC as consistent with the rationale of Hotel Continental, asserting it permitted utilities to adjust fuel costs without engaging in improper single-issue ratemaking. However, the Missouri Supreme Court disagreed, distinguishing the TAC from the FAC based on the nature of the expenses involved, while affirming the PSC's authority to differentiate among operating expenses as long as regulatory control over rates is maintained.

The Court upheld the appropriateness of a Tax Adjustment Clause (TAC) while determining that it did not necessitate the approval of a Fuel Adjustment Clause (FAC) due to their differing natures and purposes. Specifically, the Court evaluated whether the FAC constituted single-issue ratemaking and retroactive ratemaking, as argued by the appellants. It referenced the Utility Consumers Council's prior ruling that the FAC allowed electric utility rates to be adjusted based solely on one factor, failing to account for offsetting cost reductions, which contravened Section 393.270.4. This statute mandates that the Public Service Commission (PSC) consider all relevant factors in determining utility rates, rather than focusing on a single aspect.

In contrast, the TAC was validated in the Hotel Continental case, where the PSC did not need to conduct a general rate hearing for every adjustment related to tax changes. The Court noted that the PSC could appropriately account for varying tax costs in its original rate-setting process and that such costs were fundamentally different from other utility expenses. The TAC mechanism allowed adjustments for taxes while being mindful of the overall rate structure established by the PSC, whereas the FAC lacked such regulatory oversight, enabling utilities to modify rates unilaterally without PSC approval.

The excerpt addresses the distinction between various cost adjustment mechanisms in utility ratemaking, specifically focusing on the Purchase Gas Adjustment (PGA) and its comparison to the Fuel Adjustment Clause (FAC) and the Temporary Adjustment Clause (TAC). The Public Service Commission (PSC) evaluates PGAs during general ratemaking proceedings, allowing for flexibility in managing gas fuel costs, which differ from other costs due to natural gas being a resource rather than a product requiring labor and materials. The PGA allows utilities to pass on both cost increases and savings directly to consumers, contrasting with the FAC, which permitted recovery of past costs in a manner deemed retroactive ratemaking.

The PSC reviews PGAs for prudence and can disapprove them initially, ensuring transparency in rates as the PGA amount is explicitly posted. Unlike the FAC, which allowed adjustments to previously set rates, the PGA does not retroactively alter charges for past customers; adjustments apply only to future billing periods. Concerns raised about improper retroactive ratemaking regarding the Adjusted Cost Adjustment (ACA) component of the PGA are dispelled, as both PGA and ACA adjustments affect only future customers, maintaining compliance with Missouri law prohibiting redetermination of already established rates. Overall, the mechanisms are framed as valid and non-retroactive, with appropriate oversight by the PSC.

Relators contend that MGE's experimental gas cost incentive mechanism, approved by the PSC, violates Missouri law, even if the basic PGA/ACA mechanism is valid. Under this incentive mechanism, the PSC sets a benchmark price for gas at 2% below its anticipated actual cost for the following year, acknowledging the potential for actual costs to deviate from this benchmark. If actual gas costs align with or exceed the benchmark by up to 4%, the PSC permits full cost recovery, deeming it prudent. Costs exceeding the benchmark by 4% to 10% allow for only 50% recovery, with the remaining considered imprudent. A traditional prudence review is triggered for costs exceeding 10% above the benchmark, which carries a presumption of imprudence. Conversely, if actual costs fall between the benchmark and 94% of it, 50% of the savings are passed to ratepayers; if under 94%, 100% of the savings are shared. This incentive clause aims to motivate companies to minimize gas purchase costs and reduce the regulatory burden of prudence reviews. Relators do not provide sufficient rationale for invalidating the incentive mechanism, noting their primary concern is that it allows for fluctuations in the company's profit based on cost variances from the benchmark. They argue this is not unique to the mechanism, as utility profits fluctuate based on rate predictions. The PGA process is considered less likely to generate excess profits or losses compared to traditional rate cases, as it allows for corrections during yearly ACA reviews, although there remains a risk of imprudent purchases.

The company's rate of return will be influenced similarly to a general rate case due to the established incentive mechanism, which specifies that costs up to 4% over the benchmark are deemed prudent, while costs between 4% and 10% above the benchmark are considered 50% prudent. This framework minimizes unnecessary administrative costs related to prudence reviews when actual costs deviate less than 10% from forecasts. The Public Service Commission (PSC) has approved this approach on an experimental basis. Variations in fuel costs that impact profit or loss will be considered in future rate proceedings, but in the interim, the incentive mechanism helps reduce regulatory costs without leading to imprudent service cost increases. 

Concerns raised by parties regarding the PGA/ACA or the incentive PGA/ACA suggest that the PSC has permitted companies to set their rates, contrary to statutory requirements, and that the rates resemble variable rather than fixed rates, potentially conflicting with the filed rate doctrine. However, upon review, no errors were found. The FAC in Utility Consumers Council was criticized for allowing electric utilities to pass on any fuel costs, which they can control, unlike natural gas costs that are largely determined by external factors. The natural gas market has evolved, granting companies some control over their fuel costs, though FERC continues to influence which costs can be passed through. Importantly, the PSC retains its ratemaking authority by conducting a prudence review of PGA costs before implementation.

The Public Service Commission (PSC) has the authority to disallow fuel cost adjustments if deemed unreasonable or the result of imprudent purchases. When an Actual Cost Adjustment (ACA) is filed in subsequent years, the PSC can disapprove adjustments based on imprudent costs. The incentive ACA facilitates a prudence review, penalizing companies for costs exceeding 4% over a benchmark. The use of various Purchased Gas Adjustment (PGA) mechanisms does not represent an abdication of the PSC's ratemaking function, nor does it violate the filed rate doctrine. The filed rate doctrine aims to provide consumers with fixed rates for easy review of their bills. The tax adjustment charge (TAC) in *Hotel Continental* did not violate this doctrine as the tax amount was fixed. Conversely, the Fuel Adjustment Clause (FAC) in *Utility Consumers Council* violated the doctrine because the formula was fixed, but the inputs could vary based on the utility, obscuring the actual charge. The PGA, unlike the FAC, requires a specific amount adjustment to be published and approved by the PSC, allowing consumers to determine the exact rate charged. Thus, the PGA/ACA mechanisms are not in violation of the filed rate doctrine, and the PSC's approval of these mechanisms is upheld. 

In Phase I, the PSC examined MGUA's argument against the PGA clause's application to gas transporters, claiming it unfairly charges them for increased gas costs without their usage or benefit from the price changes. The PSC held a hearing on this issue, acknowledging that the PGA clause is specifically designed to pass on costs incurred by MGE in purchasing gas.

Missouri law permits MGE to use a Purchased Gas Adjustment (PGA) clause to pass gas costs to sales customers. However, MGUA contends that it is unreasonable to impose these costs on companies, like its members, that do not purchase gas from MGE but only use its pipelines for transportation. MGUA's position is rooted in the belief that costs passed through the PGA are solely linked to MGE's gas procurement. Yet, the Public Service Commission (PSC) found this assumption invalid in its September 1995 Phase I Report and Order, stating that both sales and transportation customers share responsibility for certain costs, specifically take-or-pay and transition costs. The PSC concluded that nonsales customers should contribute to these costs due to their connection to the deregulated market, which allowed them to purchase gas from other suppliers. The PSC emphasized that all customers, including those who do not buy gas directly from MGE, benefit from the deregulation and should thus share in the financial responsibility for associated costs. Despite MGUA's suggestion that the PGA clause should have a broader name to reflect its purpose, the PSC maintained that the current name, while limited, is not inconsistent with the clause's function.

The legality and reasonableness of the Public Service Commission's (PSC) order regarding the purchased gas adjustment clause is affirmed, as there is substantial evidence showing that MGUA members benefited from deregulation. The use of the PGA clause is deemed a reasonable method to distribute the costs of deregulation among beneficiaries. This decision is consistent with findings in the companion case, State ex rel. Midwest Gas Users' Ass'n v. Public Service Comm'n, where similar issues regarding transportation customers were addressed. The court rejects MGUA's arguments in the companion case that challenge the PSC's factual determinations and the adequacy of its findings and conclusions. Judges Spinden and Smith concur with this affirmation. Additional notes reference related cases and discussions concerning the natural gas industry and electric utility regulation.