Ameren Ill. Co. v. Ill. Commerce Comm'n

33 N.E.3d 987

AMEREN ILLINOIS COMPANY, Petitioner

v.The ILLINOIS COMMERCE COMMISSION;

The Citizens Utility Board;

The Illinois Industrial Energy Consumers (Archer–Daniels–Midland Company, Caterpillar, Inc., Air Products and Chemical Company, and United States Steel Corporation–Granite City Works);

and the Office of the Attorney General, Respondents.

Dominion Retail, Inc., and Interstate Gas Supply of Illinois, Inc., Petitioners

v.The Illinois Commerce Commission;

Ameren Illinois Company, d/b/a Ameren Illinois;

The Citizens Utility Board;

The People of the State of Illinois;

The Illinois Industrial Energy Consumers;

The Illinois Competitive Energy Association;

and the Retail Energy Supply Association, Respondents.

Nos. 4–14–0173

4–14–0182.

Appellate Court of Illinois, Fourth District.

June 2, 2015.

Albert D. Sturtevant (argued), Whitt Sturtevant LLP, Chicago, Edward C. Fitzhenry, Ameren Services Company, Andrew J. Campbell, Whitt Sturtevant LLP, Columbus, Ohio, for petitioner Ameren Illinois Company.

Stephen J. Moore (argued), Thomas H. Rowland, Kevin D. Rhoda, Rowland & Moore LLP, Chicago, for petitioners Dominion Retail, Inc., and Interstate Gas Supply of Illinois, Inc.

James E. Weging (argued), Special Assistant Attorney General, Chicago, for respondent Illinois Commerce Commission.

Julie L. Soderna, Christie Redd Hicks, Kristin Munsch, Chicago, for respondent Citizens Utility Board.

OPINION

Justice APPLETON delivered the judgment of the court, with opinion.

¶ 1 In tariffs it filed with the Illinois Commerce Commission (Commission), Ameren Illinois Company (Ameren) proposed increasing its rates for natural gas. The Commission suspended the tariffs and held an evidentiary hearing on them. The hearing culminated in a lengthy written decision by the Commission. Ameren appeals from one aspect of that decision, namely, the rate of return the Commission allowed Ameren on its equity. We are unable to say that, in setting the rate of return, the Commission made a decision that was against the manifest weight of the evidence. Therefore, in Ameren's appeal, case No. 4–14–0173, we affirm the Commission's decision.

¶ 2 The other appeal, case No. 4–14–0182, which we have consolidated with Ameren's appeal, arises from the same administrative case but concerns different tariffs. After filing its tariffs proposing an increase in gas rates, Ameren filed “rider” tariffs proposing the establishment of a small volume transportation program, a program that would allow retail gas suppliers to use Ameren's infrastructure to deliver natural gas to customers who chose to enter into contracts with the retail gas suppliers. The Commission approved the small volume transportation program but required retail gas suppliers to abide by three consumer protections, over and above those that statutory law already provided. Two interveners, Dominion Retail, Inc., and Interstate Gas Supply of Illinois, Inc. (which we will call, collectively, “the retail gas suppliers,” “the alternative gas suppliers,” or simply “the suppliers”), challenge the three consumer protections. They contend the Commission lacked statutory authority to require these protections, and they also contend there was no evidence that the protections were even necessary. We conclude the Commission had statutory authority to require the inclusion of the new consumer protections in the small volume transportation tariffs. The suppliers insist that little or no historical evidence justified these protections. But that is no reason to overturn them. A protection can serve the legitimate function of preventing an injury from ever happening. Viewing the new consumer protections that way, we defer to the Commission's judgment that they would be just and reasonable conditions in Ameren's small volume transportation tariffs.

Therefore, we affirm the Commission's decision in the suppliers' appeal as well.

¶ 3 I. BACKGROUND

¶ 4 A. Ameren's Revenue Requirement

¶ 5 1. The Capital Asset Pricing Model

¶ 6 a. An Introduction to This Model

¶ 7 To determine the rates a public utility may charge its customers, the Commission must determine the utility's revenue requirement. Business & Professional People for the Public Interest v. Illinois Commerce Comm'n, 146 Ill.2d 175, 195, 166 Ill.Dec. 10, 585 N.E.2d 1032 (1991). The revenue requirement equals the utility's operating costs plus the rate base multiplied by an allowed rate of return. People ex rel. Madigan v. Illinois Commerce Comm'n, 2011 IL App (1st) 100654, ¶ 26, 354 Ill.Dec. 662, 958 N.E.2d 405. In the rates a regulated utility charges its customers, it not only deserves to be compensated for its operating costs, but it also deserves a return on its investment: a return on the rate base. Id. (The “rate base” is “the total value of all invested capital.” Commonwealth Edison Co. v. Illinois Commerce Comm'n, 2014 IL App (1st) 130302, ¶ 10, 384 Ill.Dec. 320, 16 N.E.3d 713.)

¶ 8 In setting rates, the Commission has to decide what, in the mind of a reasonable investor, would be an attractive enough return on the present value of the utility's property. Id. ¶ 11. For several years, the Commission has used the capital asset pricing model (CAPM) to determine the minimum rate of return needed to entice a reasonable investor to invest in a public utility. (As we will discuss later, the Commission also uses the discounted cash flow (DCF) model. But Ameren does not appeal any aspect of the Commission's application of the DCF model in this case.)

¶ 9 According to the CAPM, the required rate of return is a function of three things: (1) a risk-free rate of return; (2) the premium that average-risk stocks must pay over the risk-free rate to entice investors; and (3) the riskiness of the utility's equity in comparison to average-risk stocks. Peter V. Pantaleo & Barry W. Ridings, Reorganization Value, 51 Bus. Law. 419, 433 (1996). The CAPM formula regards these three things as having the following relationship:

Cost of equity = R(f) + (Beta x [R(m)—R(f) ] )

Where: R(f) = risk-free rate of return

Beta = beta coefficient of the utility's stock, which measures the volatility of the utility's stock in comparison to the volatility of the market as a whole

R(m) = expected rate of return on a market portfolio comprised of a large number of diversified stocks, i.e., the expected rate of return on average-risk stocks. See id.

¶ 10 Expressed in words, the formula means this. The cost of the utility's equity—the required rate of return for the utility—“is equal to the sum of the risk-free rate of return plus a risk premium (i.e., a return above the risk [-]free rate).” Id. The formula assumes that if investing in the utility would yield a rate of return no greater than that of treasury securities, which are the prototypical risk-free investment, no sensible person would invest in the utility. The utility would be riskier than treasury securities, and any rational investor would want compensation, a premium, for the additional risk. Therefore, to entice investors, the utility has to offer a risk premium, some amount above the risk-free rate. In the formula above, the symbols to the right of the plus sign determine that risk premium.

¶ 11 The risk premium the utility must offer is determined by multiplying the volatility of the utility's equity by the market premium, the premium that investors expect the market as a whole (the average-risk stocks) to pay above a risk-free investment (treasury securities). Pantaleo and Ridings explain it this way—and for our purposes, the “target company” is the utility:

“As noted, the yield on treasury securities is generally the best measure of the risk-free rate. The difference between the expected return on a ‘market portfolio,’ like the Standard & Poor's 500, and the risk-free rate is a measure of the premium the market is expected to pay above a risk-free investment. This market premium is commonly determined by reference to published data that tracks the average return on a given market portfolio and the average return on treasury securities over the same extended period of time (usually from 1926 or 1945 to the present). * * * A beta coefficient greater than one means that a stock is more volatile than the market generally, as represented by a portfolio of a large number of stocks. * * * A beta coefficient equal to one means that a particular stock is no more or less risky than the risk of the market itself. * * * As the formula shows, a beta greater than one magnifies the cost of equity for a target firm. This makes sense because greater risk requires a greater return. Therefore, if the equity investment in a target company is riskier than the ‘average risk’ of stocks represented by a market portfolio, the premium above a risk-free investment the target would have to pay in order to attract equity investors should be some multiple (higher than one) of the premium payable by the less risky ‘average risk’ stocks. A target's beta is that multiple.” Id. at 434–35.

¶ 12 If the target company is publicly traded, its beta can be found in financial publications, such as Value Line and Zacks. But what if the target company is not publicly traded? Because Ameren is not publicly traded and hence there is no market data available for Ameren stock, the only way to estimate Ameren's beta is to use the betas of a proxy group of publicly traded gas companies that appear to pose about the same amount of risk as Ameren.

¶ 13 b. The Controversy Over Measurement Periods for the Beta

¶ 14 i. The Staff's Use of Five–Year Measurement Periods

¶ 15 The Commission's staff (Staff) entered its appearance in the administrative hearing, and a member of the Staff, Rochelle Phipps, presented her CAPM analysis. To determine the beta coefficient, she used the same proxy group of gas companies that Ameren used in its CAPM analysis (except that she excluded one company). She obtained the betas of these proxy companies from Value Line and Zacks, and she also performed a regression...