During its September term, the Illinois Supreme Court debated an issue of considerable importance to the State’s utilities. People ex rel. Madigan v. Illinois Commerce Commission is a challenge brought by the Attorney General to volume-balancing-adjustment (“VBA”) riders to approved natural gas rate schedules. Our detailed summary of the underlying facts and opinions in Madigan is here.
Utility ratemaking is largely an exercise in forecasting the future – what loads are likely to be, what the weather will be like, population changes, energy efficiency and so on. When assumptions go astray – which they almost always do, at least to some degree – rates are off what they “should” be. Certain customers might wind up overpaying or underpaying what they theoretically should, and the utility can miss its approved revenue recovery targets. The purpose of VBA riders is to adjust rates either up or down depending on whether the utility is on track to over-recover or under-recover its target revenue.
The Commission authorized Rider VBA as a four-year pilot program in 2008. While the Attorney General’s appeal from that decision was still pending, the Commission approved Rider VBA on a permanent basis in January 2012.
On appeal from that ruling, the Attorney General challenged the VBA on the grounds that it violated long-settled prohibitions on retroactive ratemaking and single-issue ratemaking. The Appellate Court held that the VBA was not retroactive ratemaking because it wasn’t based on the proposition that rates were too high; it controlled the utility’s revenue recovery. The Court further held that the VBA didn’t violate the prohibition on single-issue ratemaking, since it didn’t cause rates to move based on a single facet of the revenue recovery requirement. The Court of Appeal accordingly affirmed the order approving the Rider VBA.
Counsel for the Attorney General began the argument. He argued that the Rider VBA was impermissible not only as retroactive and single issue ratemaking, but under the basic ratemaking principles of the Public Utilities Act. Utility ratemaking had never been intended to guarantee utilities’ profits, counsel argued; it was supposed to approximate the effect of the free market. The Rider VBA, he argued, effectively moved risk from the utility to the residential and small business customers. Justice Thomas asked whether the country wasn’t moving towards riders like the VBA. Counsel answered some states have, others haven’t. In the ones that have permitted it, there are generally statutory amendments authorizing the practice. Justice Burke asked whether the idea was to give utilities an incentive to control costs and operate efficiently in the public interest. Counsel answered that the Act already has efficiency requirements. Justice Burke suggested that counsel was saying that utility rates are always subject to some sort of regulation and review even without the rider. Counsel answered that that was so, but rates are set prospectively; if revenue falls short, the utility should come back and open up a new rate case, not go back and charge consumers more for the gas they’ve already used. Justice Burke asked how the average consumer is affected by the Rider. Counsel answered that if the company doesn’t achieve its revenue goal from a particular type of customer, it imposes a monthly surcharge the following year. Justice Burke asked whether that eliminated the incentive to conserve, and counsel said no. Justice Thomas asked whether the Court should be influenced by the fact that utilities want the Rider, consumers seemed to be benefiting and environmental groups are in favor of it? Counsel argued that environmental groups often trade such Riders for a quid pro quo, but efficiency measures are already required in Illinois. Justice Theis asked whether the State’s arguments were aimed at the second phase of ratemaking – not determining a revenue requirement, but rather, designing a rate to get there. Counsel agreed. Justice Theis pointed out that many cases cited by the Attorney General actually related to the revenue requirement. Counsel answered that the plain language of the Public Utilities Act required prospective and published rates, and provide for a new rate case when revenues fall short of goals. The Court itself has said that refunds paid after rates are set are inconsistent with prospective ratemaking. Justice Theis said that was about the first prong of ratemaking, but counsel argued that there was no reasoned distinction between the two circumstances. Free market companies don’t get to go back and retroactively increase prices, counsel argued, and the defendants shouldn’t be allowed to either – the legislature has made it clear that the companies must bear the risk of achieving or missing the approved rate of return. The risk of the company falling short of its revenue allowance is built into the ratemaking process, counsel insisted, but the Rider changes that. When counsel turned to the retroactive ratemaking issue, Chief Justice Garman asked whether the issue had been waived. Counsel answered that the point had been raised regarding approval of the pilot program and expressly rejected. Accordingly, it was futile to raise the point again. Moreover, there was no unfair surprise in raising the issue, counsel argued, and it was purely legal (and thus, non-forfeitable) anyway. Counsel concluded by once again insisting that the Rider VBA was both retroactive and single-issue ratemaking. The guiding principle of ratemaking was supposed to be that when one factor changed, perhaps there were offsets elsewhere. Isolating one element of the complex equation distorts the process.
Counsel for the Commerce Commission followed. He argued that many of the cases cited by the Attorney General related to the revenue requirement step of ratemaking, which is not at issue here. The second step involves teams of economists, armed with costs and service studies, allocating the revenue requirement out to the various classes of customers. Counsel argued that the primary reason for the Rider was the recovery of fixed costs, not the cost of gas. The Public Utilities Act doesn’t prohibit the guaranteed recovery of revenue targets, counsel argued. But the ICC decided not to go that way. The Attorney General argues that the Rider VBA violates the principle of published rates, but in fact, it is published, counsel argued. Justice Theis pointed out that one of the concerns of the statute is understandable rates. Under the Rider, a consumer who is frugal and wise and conserves gas will pay more. How does that factor in? Counsel argued that such a customer would still get the benefit of the volumetric rate and have a lower bill. Chief Justice Garman asked how a consumer would know that a surcharge was coming. Counsel responded that the surcharge is published immediately before the year in which it is collected. Justice Thomas asked whether the Attorney General had done enough to preserve its retroactive ratemaking argument. Counsel said no – the challenge to the pilot program was an entirely different case.
Counsel for the utility followed. The Rider is published as a tariff, he said. Counsel characterized the Rider as triggering adjustments rather than surcharges. In fact, the utilities have returned $24.5 million to the customers since approval. Nor was it fair to say that the Rider guaranteed a certain profit level – even with the Rider, rates of return on equity have been consistently below the Commission-authorized rate. In fact, as a result of last winter in Illinois, but for the Rider, the utility would have earned in excess of the authorized rate of return – with it, the utility ultimately made below the authorized rate. Counsel argued that the Rider doesn’t change the setting of a revenue requirement, or guarantee any particular level of profitability. Counsel noted that the Attorney General had cited the principle of least cost from the Utility Act, but since the Rider is symmetrical, adjusting both to over- and under-recovery, it is consistent with the least cost principle. Justice Theis asked counsel to address the Attorney General’s argument that the Rider eliminates utility risk. Counsel answered that risk is factored into the approved rate of return. The Commission addresses any reduction in risk resulting from revenue decoupling in ratemaking – in fact, originally, there was a 10 basis point adjustment to the revenue requirement because of the change in risk. In its latest rate case order, the Commission decided not to apply that offset, since it found that many of the exemplar cases it was using to set rates also had revenue decoupling. Counsel argued that the charge that the Rider eliminates the incentive to conserve is simply untrue.
Counsel for the Attorney General argued in rebuttal that publishing the Rider doesn’t make the rate understandable – in fact, it promotes uncertainty. According to counsel, the Commission rejected the idea that reduced demand doesn’t affect fixed costs. Counsel conceded that the Rider doesn’t guarantee profits, but it does guarantee a revenue requirement that isn’t supposed to be guaranteed. The underlying assumption of traditional ratemaking is that when usage falls, a utility will make other changes to offset the loss. Justice Theis asked whether counsel for the company was correct in saying that risk is factored in at the revenue requirement stage of ratemaking. Counsel answered that it was not clear that approved profit had been lowered in response to the lowering of risk. Justice Karmeier asked whether risk to customers wouldn’t be higher without the Rider. Counsel answered that in fact, the Rider hasn’t decreased rates. Justice Karmeier referred to the claim that the utility has refunded $24.5 million because of the Rider, and asked whether that was a proper factor to consider. Counsel said no, the issue was legal. That refund was the result of an unusually bad winter; in other years, the Rider would result in surcharges. Counsel concluded by arguing that the Rider wasn’t aimed at any factor outside the utility’s control – even weather is forecast as part of a rate case.