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decided: April 7, 1978.



Edward J. Morris, Counsel, PUC, Michael P. Kerrigan, Asst. Counsel, PUC, Harrisburg, for appellant.

Ernest R. von Starck, Philadelphia, for appellee.

Jones, C. J., and Eagen, O'Brien, Roberts, Pomeroy, Nix and Manderino, JJ. Pomeroy, J., filed an opinion in support of affirmance joined by O'Brien and Manderino, JJ. Roberts, J., filed an opinion in support of reversal joined by Eagen, C. J., and Nix, J. Jones, former C. J., did not participate in the decision of this case.

Author: Per Curiam

[ 477 Pa. Page 597]


The Court being equally divided, the order of the Commonwealth Court is affirmed.

[ 477 Pa. Page 598]


POMEROY, Justice.

In this public utility rate case, the Pennsylvania Public Utility Commission (PUC) appeals from a decision of the Commonwealth Court to reverse an order of the PUC which had disallowed $57,906 from a general rate increase proposed by the appellee water utility, Keystone Water Company -- White Deer District (Keystone). See 19 Pa. Commw. 292, 339 A.2d 873 (1975).*fn* The subscribers to this opinion would affirm the order of the Commonwealth Court.

This case arises from Keystone's filing on August 31, 1972, of a supplement to its existing water tariff. The supplement proposed changes in all metered rates sufficient to produce an increase in annual revenues of $415,477.*fn1 Pursuant to an investigation of the reasonableness of these rates, the PUC issued an order postponing the effective date of the increase until August 22, 1973; thereafter the new rates were deemed temporary pending a final PUC adjudication. Based upon hearings and the submission of appropriate data, the Commission entered a detailed final order on April 17, 1974. Of Keystone's $423,356 requested increase in revenues (as revised), $365,450 or 86 per cent was permitted. This decrease of $57,906 is principally explained by the fact that the PUC excluded from the computation of the rate base the value of Keystone's White Deer Creek filtration plant; the Commission also eliminated from allowable operating expenses

[ 477 Pa. Page 599]

    the annual depreciation chargeable to the plant. This determination by the PUC to ignore Keystone's filtration plant for rate-setting purposes is the single issue in this appeal.

To appreciate the basis for the Commission's action, some background is necessary. We quote from the summarized facts as set forth in the opinion of the late Judge Kramer, writing for the Commonwealth Court majority:*fn2

"For almost 75 years, one of the three sources of water for Keystone was the White Deer Creek watershed (watershed). The area of the watershed above Keystone's intake point is approximately 37 square miles. The watershed was almost entirely forest land and Keystone owned about 1,300 acres in fee. Approximately 10 per cent of the watershed is owned by the Commonwealth and is maintained as state forest land. For the remaining 90 per cent, Keystone holds deeds granting water rights dating back to about 1902, wherein it is stated that Keystone has the complete control and use of all the waters and the right to enter upon the land at all times for the purpose of maintaining its supply of water. This water was so pure that it required no treatment other than the minimal chlorination required by the Department of Health for all public water companies. In 1959 Keystone became aware that the Commonwealth proposed to construct Interstate Highway I-80 through the valley of the White Deer Creek. Keystone advised the Pennsylvania Department of Transportation (PennDOT) of the danger to its water supply but was unsuccessful in attempting to have I-80 rerouted so as not to touch the watershed. As a result of long, involved negotiations with PennDOT concerning Keystone's condemnation rights, an understanding was reached and reduced to a written agreement dated July 18, 1966." 19 Pa. Commw. 292, 295-96, 339 A.2d 873, 874 (1975) (footnote omitted.)

Settlement under the July 18, 1966 condemnation agreement between the Pennsylvania Department of Transportation

[ 477 Pa. Page 600]

    and Keystone Water Company, the pertinent portions of which are quoted in the margin,*fn3 was made on March 30, 1967. In the spring of 1968, construction of a new filter plant built at Keystone's expense, as provided by the agreement, was completed. The cost of construction of the plant was $1,100,000. Additional expenses related to the condemnation and the building of the new plant brought Keystone's total investment in the project to approximately $1,300,000, a sum equivalent to that paid by PennDOT to Keystone pursuant to the terms of the agreement. See n. 3, supra.

In its 1974 rate adjudication, the PUC undertook a review of the 1967 PennDOT condemnation settlement. It construed

[ 477 Pa. Page 601]

    the terms of the parties' written agreement as compensating Keystone only for the value of 130 acres of land to which PennDOT took title.*fn4 The remainder of the amount paid in settlement ($1,292,347), according to the PUC, was intended to remedy "consequential damages" suffered not by the utility, but by its ratepaying customers. As support for this theory, the PUC in its memorandum order pointed to the agreement provision requiring the utility company to construct a filter plant which would restore the potability of the White Deer Creek water supply. The Commission thus ordered that $1,292,347 be excluded from the calculation of rate base.

On appeal, the Commonwealth Court rejected the PUC theory and held as follows:

"[T]he payment of $1,300,000 to Keystone by PennDOT was a payment in money damages or just compensation for the taking of Keystone's property as measured by the value of the land taken, the value of the deeded water rights taken, and also for the replacement costs involved in insuring the continuance of supply of potable water to Keystone's customers, the latter damages of which were measured by the 'cost to cure' method. Upon payment of those damages, the money was properly accounted for in the surplus account because that money belonged to the stockholders of Keystone. We hold that the money or property of the stockholders of Keystone having been invested in a filtration plant used and useful in the public service of Keystone's customers, the value of that plant should have been included in the various original costs, reproduction costs (or trended original costs) and fair value evaluations as part of the total rate base of Keystone for rate-making purposes. We hold that since the filtration plant should be made a part of the rate base for rate-making purposes that annual depreciation should be allowed so that Keystone may recoup this investment over the life of the plant. In view of these holdings, we must

[ 477 Pa. Page 602]

    reverse the PUC and remand this matter to it for the purpose of amending the cost of service . . . ." 19 Pa. Commw. at 310-11, 339 A.2d at 882. (footnote omitted).

For reasons stated in Part I of this opinion, we concur in the holding of the Commonwealth Court that Keystone's filtration plant must be included in rate base for purposes of calculating allowable return on investment, as well as allowable depreciation expense. In Part II, we address the principal argument put to us by the PUC in the instant appeal, viz., that the Commission is free to depart from adherence to the rate base method of utility rate adjudication wherever the end result (i. e., the revenue which the utility is permitted to earn) is deemed to be "just and reasonable."


We find no legal or factual support*fn5 for the conclusion of the PUC that most of the dollars representing Keystone's filtration plant were not damages properly belonging to Keystone as compensation for the 1966 taking of its watershed land and valuable easement rights,*fn6 but were "consequential damages" owing to utility consumers and thus excludable from Keystone's rate base. It is our view that the proper interpretation of the PennDOT-Keystone agreement of July 18, 1966 is that it represents a settlement negotiated by the parties thereto pursuant to established

[ 477 Pa. Page 603]

    condemnation principles, and that the proceeds therefrom were thus the property of Keystone and its shareholders.

It is true, as is emphasized in the Commission's order, that the agreement was intended to insure the "continuance of a supply of potable water to the communities which [the] Company serves." That feature of the settlement, however, was simply reflective of applicable condemnation law, which envisions that the injured utility will remedy the damage done to its service capacity. In Pa. Gas & Water Co. v. Pa. Turnpike Commission, 428 Pa. 74, 236 A.2d 112 (1967), this Court ruled that land held for reservoir purposes by a water utility was to be compensated for, when condemned by the Turnpike Commission, on a basis of cost to "replace or repair", rather than the more typical "fair market value" calculation of damages. See also McSorley v. Avalon Borough School District, 291 Pa. 252, 139 A. 848 (1927). This was principally because there existed no market for such utility property. 428 Pa. at 83, 236 A.2d 112. In the present case, it was certainly no less difficult to arrive at a market value for Keystone's watershed property. The parties accordingly chose to settle on this "cost to cure" basis.*fn7 That the parties went a step further and agreed that the condemnee would in fact repair the damage done to its watershed by constructing facilities to insure continued purity of the water supply does not alter the fact that the settlement figure represented compensation for Keystone's loss, not a gift or donation by PennDOT to either Keystone or its

[ 477 Pa. Page 604]

    customers.*fn8 The Public Utility Commission in its rate adjudication effectively rewrote the Keystone-PennDOT agreement so as to delete the provision granting compensation in the sum of $1.3 million, representing the watershed value of the condemned acreage (including value derived from deeded easements) and inserted in its place a provision bestowing a gratuity in like amount on Keystone customers. We believe that in so doing it committed error.

The PUC argues, however, that its order was compelled by equitable considerations which also dictate the affirmance of that order. It is argued that to permit Keystone to obtain a return on the filter plant is to confer a windfall on the utility to the detriment of the rate paying public. We cannot agree with this assertion. The PUC's equity argument seems to reflect concern with the disparity between the carrying value of the land and water rights taken or destroyed by the condemnation, and the amount agreed upon in settlement, coupled with the fact that this amount bears a close correlation to the cost of the new plant. But the matter must be seen in context. The fact is that the water rights taken, whatever their cost of acquisition many years ago, were of unique value to Keystone, and only to Keystone. The current value of these property rights was not ascertainable by conventional methods because there was obviously no market for them at the time of condemnation. Keystone was sufficiently farsighted at the turn of the century to procure easements which were extensive enough to assure a plentiful source of pure water, a supply kept untouched by polluting influences with which our land and streams are today afflicted. It should not be penalized because of the fact that the only standard of compensation for the loss of such an asset is the amount necessary to be spent in order to accomplish by artificial means what formerly was accomplished by natural means.

[ 477 Pa. Page 605]

That this amount is substantially greater than the original investment of Keystone in its property rights is an irrelevancy, and in no wise converts the settlement with PennDOT from damages for a taking into a voluntary contribution. Without the construction of the new plant the customers of Keystone would have been without drinking water (a circumstance caused by PennDOT, not Keystone); thus they have been benefited by that construction. It does not seem unjust that the rates charged to consumers should be increased to reflect the costs of obtaining purity by artificial rather than natural means. Conversely, for Keystone and that portion of the public who are its shareholders to be left with an asset on which no return and no depreciation are to be allowed for purposes of rate-making would mean that it has virtually nothing to show for the taking of its valuable rights to a protected watershed. That result would indeed seem unjust.

[ 477 Pa. Page 606]

Furthermore, we think it pertinent to observe that it is basic to Pennsylvania utility rate law that calculations of rate base must include all property rightfully belonging to a utility company which is used and useful in service to the public. See Scranton v. Scranton Steam Heat Co., 405 Pa. 397, 401, 176 A.2d 86, 88 (1961); Lower Paxton Township v. Pa. P.U.C., 13 Pa. Commw. 135, 140, 317 A.2d 917, 920 (1974). This is so irrespective of the source or cost of the property. Thus, in Scranton, supra, our Court held that the PUC erred in valuing a steam heating plant at the fortuitous price the utility paid to acquire it; the much higher original cost of construction and the even higher cost of present reproduction were to be considered as well. 405 Pa. at 402-03, 176 A.2d 86. Similarly, in Beaver Valley Water Co. v. Public Service Commission, 76 Pa. Super. 255, 263-64 (1921), it was held that the fact that the source of funds for the construction of a dam abutment was furnished by a third person was irrelevant to rate base valuation: "It matters not who paid for it if it forms part of appellant's plant and is used in connection with the public service. It is no part of our duty to measure the value of the consideration given by appellant under said agreement." See also Peoples Natural Gas Co. v. Page 606} Pa. P.U.C., 153 Pa. Super. 475, 34 A.2d 375 (1943); Borough of Lewistown v. Public Service Commission, 80 Pa. Super. 528 (1923).*fn9

In the present case, the utility's filtration plant is devoted to providing adequate water service to the public. That the capital invested in that facility is traceable to a payment of damages for injury to the company's water supply is immaterial for rate-setting purposes.*fn10 We conclude, therefore, that the value of this item of Keystone's utility property must be restored to rate base and must be considered for purposes of calculating depreciation expense. See Scranton, supra, 405 Pa. at 403-04, 176 A.2d 86.*fn11


To put in context the Commission's principal argument in this case, it is helpful to review briefly some first principles

[ 477 Pa. Page 607]

    of utility rate adjudication in Pennsylvania. In the first place, Section 301 of the Public Utility Law, supra, 66 P.S. ยง 1141, sets forth the fundamental criterion that "[e]very rate made, demanded, or received by any public utility . . . shall be just and reasonable." Our courts have consistently held that the process of implementing this standard and determining allowable revenues upon which customer rates are founded is one of calculating the fair value of a utility's property used and useful in public service (termed the "rate base") and multiplying that amount by a percentage figure called "rate of return" (most frequently determined by reference to the company's cost of capital). See, e. g., Scranton, supra ; Lower Paxton Township, supra ; Pittsburgh v. P.U.C., 182 Pa. Super. 376, 126 A.2d 777 (1956).*fn12 Secondly, with regard to the rate base element, ascertainment of the fair value of utility property has required consideration of two approaches to valuation: original cost of construction and cost of reproducing anew the plant facilities. See Scranton, supra, 405 Pa. at 402, 176 A.2d 86, and cases cited therein.

These two precepts, the first relating to the overall method to be used for setting rates and the second to the particular meaning accorded to the term "fair value", have their roots in federal constitutional law. "Rates which are not sufficient to yield a reasonable return on the value of the property used . . . are . . . confiscatory, and their enforcement deprives the public utility company of its property in violation of the 14th Amendment." Bluefield Water Works v. Public Service Commission, 262 U.S. 679, 690, 43 S.Ct. 675, 678, 67 L.Ed. 1176, 1181 (1923). "And in order to ascertain that value, the original cost of construction . . . [and] the present as compared with the original cost of construction . . . are all factors to be considered." Id. (quoting Smyth v. Ames, 168 U.S. 466, 18 S.Ct. 418, 42 L.Ed. 819 (1898)).

[ 477 Pa. Page 608]

As we understand its position, the Public Utility Commission now contends that it is not constrained by the aboveoutlined rate base/rate of return adjudicatory formula (and thus is free to give no specific consideration to Keystone's filtration plant as an element of rate base) where the end result, i. e., the revenues permitted to be received by the utility, may be deemed to be just and reasonable. This approach is valid, we are told, because the Supreme Court of the United States has effectively overruled Bluefield, supra, by holding that it is the result reached, and not the method employed, which is controlling for purposes of constitutional inquiry. See Federal Power Commission v. Hope Natural Gas, 320 U.S. 591, 64 S.Ct. 281, 88 L.Ed. 333 (1944); Federal Power Commission v. Natural Gas Pipeline, 315 U.S. 575, 62 S.Ct. 736, 86 L.Ed. 1037 (1942); cf. Permian Basin Rate Cases, 390 U.S. 747, 88 S.Ct. 1344, 20 L.Ed.2d 312 (1968). The Commission cites the following from Hope, supra :

"Rates which enable the company to operate successfully, to maintain its financial integrity, to attract capital, and to compensate its investors for the risks assumed certainly cannot be condemned as invalid, even though they might produce only a meager return on the so-called 'fair value' rate base." Id. 320 U.S. at 605, 64 S.Ct. at 289.

Since Keystone has allegedly failed to demonstrate that the PUC's order will impair its financial integrity, etc., the Commission asserts that there has been no error in this case.

We must disagree. Even assuming that the PUC correctly reads the Supreme Court's Hope decision,*fn13 our courts have held that the rate base method of rate-setting is mandated by our statutory law, irrespective of whether the federal constitution would require as much. See Peoples Natural Gas Co. v. Pa. P.U.C., 153 Pa. Super. 475, 488-89, 34 A.2d 375, 382 (1943); Pittsburgh v. Pa. P.U.C., 158 Pa. Super. 229, 235-36,

[ 477 Pa. Page 60944]

A.2d 614, 616-17 (1945). The legislative intent to prescribe the rate base technique can be garnered from several sections of our Public Utility Law.*fn14 We are of the view, furthermore, that sanctioning of a free-form "end result" approach to rate-making would be unwise policy. Absent the legal standards implicit in the present rate base/rate of return model, a Commission order and judicial review thereof would be transformed into an uncertain groping for the elusive standards of "justness" and "reasonableness"

[ 477 Pa. Page 610]

(or the equally vague factors identified in the quoted passage from Hope, supra). While the judgment of the Commission is entitled to great weight, it should not be effectively conclusive upon a reviewing court. We think it would become so if the ephemeral approach now advocated were to prevail. It is for this reason that several other courts, and commentators as well, have rejected the suggestion that the rate base technique be abandoned. See Iowa-Illinois Gas & Electric Co. v. City of Fort Dodge, 248 Iowa 1201, 85 N.W.2d 28 (1957); Illinois Bell Telephone Co. v. Ill. Commerce Commission, 414 Ill. 275, 111 N.E.2d 329 (1953); Petition of New England Tel. & Tel. Co., 115 Vt. 494, 66 A.2d 135 (1949); Commonwealth Telephone Co. v. Public Service Commission, 252 Wis. 481, 32 N.W.2d 247 (1948); E. McKeage, Public Utility Law Regulation 74-80 (1956); Priest, supra, at 139-190; Joslin & Miller, "Public Utility Rate Regulation: a Re-Examination", 43 Va.L.Rev. 1027, 1031-1049 (1957); Rose, "Valuation for Rate-making", 47 Minn.L.Rev. 1, 25 (1962); Welch, "Rate Base is Here to Stay!", 52 Pub.Util.Fort. 635 (1953); Contra, City of Detroit, Michigan v. Federal Power Commission, 97 U.S.App.D.C. 260, 230 F.2d 810 (1955).*fn15

[ 477 Pa. Page 611]

We realize, of course, that our traditional approach to rate-making has not reached the status of a science and that some pragmatic weighting of various factors is necessarily involved. We remain unpersuaded, however, that abandonment of the rate-base approach and the concept of fair return based thereon would be useful or helpful in the complicated process of utility rate-making, or that such a change in our law and practice is required in the public interest. We therefore must reject ...

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