In the closing days of its January term, the Illinois Supreme Court unanimously affirmed the Appellate Court’s decision in People ex rel. Madigan v. Illinois Commerce Commission, approving the use of the so-called volume-balancing-adjustment rider (or “Rider VBA”) on a natural gas utility’s bills. Our detailed summary of the facts and Commission and court opinions in Madigan is here. Our report on the oral argument is here.
In order to understand the debate over the Rider VBA, it’s necessary to briefly review how ratemaking at the Commerce Commission works. The Commission starts by determining the utility’s revenue requirement. The idea is to set that requirement at a level sufficient to recover costs plus a return on investment sufficient to enable the utilities to attract capital in financial markets at competitive rates. A major component of the utility’s costs is the cost of distribution. To a considerable degree, distribution costs are fixed, but traditionally, rates have been quite dependent on volume. Volume forecasts are dependent to a considerable degree on weather forecasts, and weather forecasts are not an exact science – particularly when they’re semi-long range. So utilities tend to over-recover their distribution costs when demand is high, and under-recover when demand is low.
The Rider VBA is intended to decouple fixed costs from their dependence on volume, and thereby prevent both under-recovery and over-recovery. If revenues dip below a level set by the Commission, the utility issues a surcharge. If revenues are above the preset level, the company issues credits. As the Court pointed out, one reason that Rider VBAs have gotten a lot of attention from both companies and regulators is that by reducing the utility’s dependence on volume, it lessens any financial incentive to discourage – or at least, not actively encourage – energy efficiency.
The Commission approved the Rider VBA as a pilot program in 2008. The Attorney General appealed. While that appeal was still pending, the Commission approved the Rider VBA on a permanent basis in 2012. The Attorney General appealed again. The Appellate Court affirmed the Commission’s permanent approval, rejecting the Attorney General’s claims that it violated prohibitions against retroactive and single-issue ratemaking.
In an opinion by Justice Theis, the Supreme Court affirmed. The Court began with the most fundamental issue of all – the standard of review. The Attorney General had argued that whether or not Rider VBA was permissible under the Act was ultimately a matter of statutory construction, but the Court disagreed. The Court disagreed, pointing out that review of Commission decisions is deferential pursuant to the Act. This was especially true in the area of fixing rates, an area heavily dependent on the Commission’s experience and expertise in the field.
The Attorney General had argued that the Rider VBA violated what it called “rate-of-return principles” built into the Act. According to the State, utility ratemaking has never been meant to guarantee the utility a certain level of profit. Rather, it’s intended to give the utility a reasonable chance at that level of revenue, if the business is properly managed. The Court disagreed. The utility is entitled to the revenue requirement set by the Commission, the Court held. So the Rider VBA, by ensuring that the utility will actually recover that requirement, no more guarantees a profit that the setting of a revenue requirement does. The State wasn’t challenging the revenue requirement which had been set by the Commission, the Court pointed out; it was merely challenging the vehicle – the Rider VBA – chosen to achieve that requirement. And the Commission’s decision on that vehicle was entitled to substantial deference.
The Attorney General also challenged the Rider VBA as violating the long-settled prohibition against single-issue ratemaking. The single-issue rule is based on the recognition that ratemaking depends on many variables of cost and demand. To change rates based on a change in one variable ignores the possibility that changes in another variable might offset the change, with no net effect on the company’s revenue. The Court rejected the State’s argument for two reasons. First, the rule against single-issue ratemaking only applies in full-blown rate proceedings. Second, the rule doesn’t bar the Commission from approving riders when a utility faces unexpected shortfalls in income, or increases in expenses.
Finally, the Attorney General challenged the Rider VBA as retroactive ratemaking. The Appellate Court had considered the Attorney General’s challenge even though the Attorney General failed to raise the issue in their application for rehearing, but the Court said that was error. The Appellate Court’s jurisdiction over the Commission’s decisions extended only as far as the Act provided, the Court pointed out. Parties seeking to invoke that jurisdiction were required to strictly comply with the Act. Since the Attorney General hadn’t raised the issue below, the Court held that the Appellate Court had no authority to consider it.