Southern California Edison Co. v. Public Utilities Commission

576 P.2d 945, 20 Cal. 3d 813, 144 Cal. Rptr. 905, 24 P.U.R.4th 588, 1978 Cal. LEXIS 203

• Court: California Supreme Court
• Decided: March 23, 1978
• Docket: S.F. 23500
• Status: Published

Opinions

Opinion

MOSK, Acting C. J.

By this petition for writ of review Southern California Edison Company (Edison) challenges the lawfulness of portions of Decision No. 85731 of respondent Public Utilities Commission which require it to amortize, by 36 months of billing credit to its customers, substantial overcollections generated by operation of its “fuel cost adjustment clause.” Edison’s principal contention is that because the funds in issue were lawfully collected pursuant to a rate structure found by the commission to be just and reasonable at the time, the order to return them constitutes illegal “retroactive ratemaking.” We conclude that the contention is without merit and the decision should be affirmed.

If the prohibition against retroactive ratemaking is to remain a useful principle of regulatory law and not become a device to fetter the commission in the exercise of its lawful discretion, the rule must be properly understood. In Pacific Tel. & Tel. Co. v. Public Util. Com. (1965) 62 Cal.2d 634 [44 Cal.Rptr. 1, 401 P.2d 353] (hereinafter Pacific Tel. & Tel.), the first decision of this court on the question,¹ we construed Public Utilities Code section 728 to vest the commission with power to fix rates prospectively only.² But we did not require that each and every act of the commission operate solely in futuro; our decision was limited to the act of promulgating “general rates.” Thus we held (at p. 650 of 62 Cal.2d) that “the Legislature has not undertaken to bestow on the commission the power to roll back general rates already approved by it under an order which has become final, or to order refunds of amounts collected by a public utility pursuant to such approved rates and prior to the effective date of a commission decision ordering a general rate reduction.” (Italics added.) And we concluded by reaffirming (at p. 655) “the rule that general rate making is legislative in character and looks to the future.” (Italics added.)

Pacific Tel. & Tel. was precisely such a general ratemaking case. There the commission conducted an extensive investigation of the rates charged by the utility in question, found them to be unreasonably high, and fixed new lower rates. In addition, however, the commission ordered the utility to refund to its customers all charges collected in excess of the new rate level since the beginning of the investigation. The order, of course, resulted in the new general rate structure taking effect retroactively, a disposition which we ruled beyond the statutory power of the commission.³

The second decision of this court applying the rule against retroactive ratemaking was City of Los Angeles v. Public Utilities Commission (1972) 7 Cal.3d 331 [102 Cal.Rptr. 313, 497 P.2d 785] (hereinafter City of Los Angeles I). There the commission, after full hearings, found a utility’s rates to be unreasonably low and fixed new higher rates. We issued a stay permitting the increased rates to be collected subject to refund pending our ruling on the petition for writ of review. In due course we annulled the decision, while recognizing that some rate increase was justified. The utility requested that we remand the case to the commission for the fixing of new rates and that the refunds be limited to the difference between such rates and those prescribed in the annulled decision. Again such an order would evidently have had the effect of permitting a new general rate structure to operate retroactively. We therefore reiterated the rule of Pacific Tel. & Tel. that “general rate making is legislative and looks to the future” (7 Cal.3d at p. 338), and directed refund of the entire rate increase. (Id. at pp. 356-357.)

We question neither the rule stated in the foregoing decisions nor its application to the facts there presented. But this is not such a case. At the risk of belaboring the obvious, we observe that before there can be retroactive ratemaking there must at least be ratemaking. There undoubtedly was ratemaking in both Pacific Tel. & Tel. and City of Los Angeles I; as we shall explain, however, ratemaking within the meaning of the cited decisions did not occur in the case at bar.

We begin with a review of the factual and legal background of this dispute. In a general rate proceeding in 1971 the commission granted Edison a rate increase of $105.5 million so that it might realize a return of 7.9 percent in the test year 1972. (Re So. Cal. Edison Co. (1971) 72 Cal.P.U.C. 282, 317.) The commission’s estimate for Edison’s cost of fuel in 1972 was based on actual prices paid in the period preceding the decision.. In the months following the decision, however, Edison’s fossil fuel costs—together with those of all utilities—rose substantially. Edison thereupon filed an application for immediate rate relief and for authority to amend its tariff to include an adjustment clause permitting periodic future billing adjustments “to reflect future increases in the cost of fuel.” The commission granted an immediate rate increase of $14.3 million, and authorized the requested fuel clause. (Re So. Cal. Edison Co. (1972) 73 Cal.P.U.C. 180.)

The clause operated as follows: at regular intervals Edison prepared a forecast of the quantity of fossil fuel it would need to purchase in the ensuing 12-month period under average weather conditions. It then calculated the cost of such fuel at current prices, and compared that figure with the cost of the same quantity of fuel at the prices reflected in its existing base rates. If the difference worked out to .001 cent per kilowatt-hour or more,⁴ Edison notified the commission of this fact by filing an “advice letter” requesting authority to increase future billings to compensate for its predicted higher fuel expenses.

Formal hearings on such requests were not contemplated; during the period here in issue none was held, and commission approval was routinely granted. In each instance the ensuing adjustment was then a matter of simple arithmetic: on each bill the number of kilowatt-hours sold was multiplied by the “fuel cost adjustment billing factor” necessary to raise the additional revenue, and the resulting “adjustment amount” was added to the customer’s monthly charge. The process was repeated in each billing until the next such adjustment was granted and took effect, and revisions of the billing factor were permitted as often as every three months. (Id. at pp. 184-185.)⁵

It is important to keep in mind that the periodic adjustments in Edison’s rates brought about by operation of the fuel clause were intended to contain no element of profit whatever. A utility’s rates are essentially the sum of two distinct components: its operating expenses and its return on invested capital. “The basic principle [of ratemaking] is to establish a rate which will permit the utility to recover its cost and expenses plus a reasonable return on the value of property devoted to public use.” (Italics added.) (City and County of San Francisco v. Public Utilities Com. (1971) 6 Cal.3d 119, 129 [98 Cal.Rptr. 286, 490 P.2d 798].) It is thus elementary regulatory law that the “return”—i.e., the profit—of the utility is calculated solely on the rate base—i.e., the capital contributed by its investors; the utility is not entitled to earn an additional profit on its expenses, but only to “recover” them on a dollar-for-dollar basis as part of the rates. A fortiori, the same principles apply to an increase in rates resulting from operation of a fuel cost adjustment clause: as its name indicates, the purpose of such a clause is to permit prompt rate adjustment to offset unusual changes in fuel costs, and no portion of such a rate increase may lawfully represent a profit to the utility.

It is clear that the fuel clause in the case before us was designed to operate within the law. The commission set forth its reasons for adopting the clause in a formal finding of fact: “Edison’s proposed fuel cost adjustment billing factor will be adopted because (1) in an inflationary period with rapid changes in the cost of fuel, an expedited method is required to permit a utility to recover these costs so that its ability to function is not impaired; (2) because fuel costs are at least 20 percent of Edison’s total costs, an expedited proceeding to recover these increases will lessen the frequency of general rate cases; and (3) the provision enhances a utility’s position in the financial community.” (Italics added.) (Re So. Cal. Edison Co. (1972) 73 Cal.P.U.C. 180, 190.)

As the emphasized language demonstrates, the purpose of Edison’s fuel clause was primarily to permit the company to “recover” its increased fossil fuel costs in an expedited manner.⁶ When in the following year the commission authorized the use of a similar fuel clause by the other major California electric utilities, it reiterated that purpose each time in identical words. (Re Pacific Gas & Electric Co. (1973) 74 Cal.P.U.C. 781, 790-791; Re San Diego Gas & Electric Co. (1973) 75 Cal.P.U.C. 267, 274.) And throughout the decision now under review the commission consistently describes the purpose of such fuel clauses as “dollar for dollar reimbursement” for the increased cost of fossil fuel. (79 Cal.P.U.C. 758, 762; see also id. at pp. 764, 766, 773.)

Edison, however, appears to view its fuel clause as a device for accomplishing a wholly different purpose. This was made crystal clear in the lengthy testimony of Norman L. Codd, Edison’s rate structure engineer and expert witness. Mr. Codd repeatedly denied that the fuel cost adjustment was an emergency measure with the limited goal of producing just enough additional revenue to offset specific, extraordinary increases in fossil fuel expenses; speaking for his company, he described the adjustment instead as a miniature rate proceeding intended to generate whatever higher rates were deemed necessary to prevent “decay” in the utility’s overall rate of return on invested capital. These views were confirmed, for example, in the following exchange between the commission examiner and Mr. Codd:

“Q. [by Examiner Blecher]. That means, Mr. Codd, it doesn’t make any difference what you collect, hoping you don’t exceed the rate of return that is authorized,... is that correct? A. That is correct.

“Q. So that the fuel clause, there is no relationship to the fuel expense,... isn’t that the effect of what you are saying? A. We are saying that the fuel clause itself, the revenues that come from it should not be compared directly with the expenses but rather [with] the total revenues derived by the base rates ... to determine if the rate of return that the Commission found reasonable is being attained.

“Q. And you don’t need a fuel clause, you just need a general rate case each time you need a rate increase because the effect of what you are saying would ignore the base purpose of the fuel clause, that is to provide emergency funds to the utility for its immediate excessive fuel costs over that which was used in computing the rates in the last rate case, is that a fair statement, Mr. Codd? A. If the base rates could in fact be revised often enough ... to result in a rate of return that the Commission has found reasonable, then I would say yes, we do not need a fuel clause. Unfortunately, our experience has shown otherwise.

“Q. Why do you need a fuel clause when you say that the amount of revenue that you collect under the fuel clause has absolutely no relation to the fuel expense as long as the amount of revenues do not cause you to exceed authorized rate of return? A. Without a fuel clause, the additional expenses that are incurred when we have increasing . . . fuel costs are such that the rate of return would decay, and we are tiying to avoid that decay by ... increasing prices.” (Italics added.)⁷

This distortion of the purpose of the fuel clause permeates Edison’s treatment of its overcollections of rates which began to accumulate shortly after the clause was put into effect.⁸ Edison invoked the clause at every opportunity between May 1972 and December 1974, and in so doing raised its rates no less than 12 times. By the end of 1974, the cumulative total of costs charged to Edison’s customers by operation of the fuel clause alone reached approximately $408 million.⁹ During the same period, however, Edison’s actual fossil fuel needs turned out to be far lower than predicted. The primary reason was unusually heavy precipitation during the 1972-1973 and 1973-1974 seasons. The phenomenon caused a substantial increase in the availability of hydroelectric power, which is a much cheaper source of energy than fossil fuels.¹⁰ As a result, Edison spent considerably less for fossil fuels—and in particular for oil—than it had estimated in computing its adjustments under the fuel clause. Indeed, by the end of 1974 Edison had spent only $262.2 million of the $408 million billed for fuel expenses, leaving the company holding $145.8 million more than it needed to offset increased fuel costs. (Auditor General’s Rep. p. 4.)

Not surprisingly, at the hearings below Edison’s witness was extremely reluctant to admit that the company in fact treated such overcollections as earnings; rather, he took refuge in the repeated assertion that the funds could not be “isolated” from Edison’s overall revenues.¹¹ It clearly appears from published figures, however, that Edison’s overcollections pursuant to the fuel clause were not only large in the absolute sense, they amounted to a very significant proportion of the company’s general revenue picture. For example, for the year 1974 Edison reported a total net income from all sources of $218.3 million;¹² yet during the same 12-month period, according to Edison’s own figures filed with the commission in compliance with the decision under review, Edison’s net fuel clause overcollections were $122.5 million—in other words, they constituted more than 56 percent of the company’s systemwide net income for the entire year. Moreover, that net income was itself 47.8 percent higher than in the previous year, even though sales were lower; Edison’s reported earnings per share were $4.10 for 1974, as compared with $2.70 for 1973; and the company’s board of directors voted to increase the common stock dividend in 1974, the first such raise in three years. (Annual Rep., p. 4.) In announcing all these benefits to the shareholders, Edison acknowledged that the fuel clause adjustments, together with a general rate increase in late 1973, “contributed substantially to higher revenues.” (Ibid.)

These continuing overcollections by Edison and other electric utility companies did not pass unnoticed. On the contrary, they triggered a sequence of public complaints, investigations, and proposals for reform or abolition of the entire fuel clause procedure. Among the most vocal critics were consumer groups (e.g., The Fuel-Adjustment Caper (Nov. 1974) 39 Consumer Rep. 836) and organs of the Congress (see Rep. of Subcom. on Oversight and Investigations of House Com. on Interstate and Foreign Commerce on Electric Utility Automatic Fuel Adjustment Clauses (Oct. 1975) passim).

13 The same overcollections were the primary incentive for the commission’s order instituting the present investigation into the use and abuse of the fuel clause in California.

14

While sharing many of the concerns voiced by critics of the clause, the commission determined that the cost adjustment concept should be preserved but the clause should be modified to eliminate the defects revealed by experience. The principal such defect, as we have seen, was the provision authorizing Edison to base its calculations on a prediction of its fossil fuel needs for the 12-month period following each application for a billing adjustment, premised on the assumption that “average” weather conditions would prevail throughout that time. The commission abandoned this procedure, and in lieu thereof adopted a clause which operates on a “recorded data” basis, i.e., on the actual fuel expenses incurred by the utility during the period preceding its application for a billing adjustment.¹⁵ The utility is now required to maintain a monthly “balancing account,” into which it will enter the amount by which its actual energy cost for the month was greater or less than the revenue generated by the clause; and on each occasion hereafter that the clause is invoked, the billing factor will be adjusted so as to bring the balance of this account back to zero. By this device the possibility of large over- or undercollections accumulating in the future is eliminated. And because the commission expanded the clause to include all sources of purchased energy—e.g., nuclear and geothermal, in addition to fossil fuels—it renamed the device the “energy cost adjustment clause.”¹⁶

There remained, however, the massive overcollections accumulated by Edison, PG&E, and San Diego under the old fuel clause.¹⁷ Treating these funds in essentially the same way as the monthly over- or undercollections to be adjusted under the new energy clause, the commission directed each utility to calculate a “fuel collection balance,” i.e., the amount by which its actual fossil fuel cost incurred since its fuel clause took effect was greater or less than the revenue generated by the clause. But rather than subjecting the utilities to the financial hardship of reducing that balance to zero in a single stroke, the commission adopted a proposal urged by PG&E of allowing the companies to gradually amortize the sum by monthly billing credits spread over a period of three years.¹⁸ That time span, the commission found, “is a fair and reasonable initial time period over which to amortize such difference, without unduly burdening either the utility or the ratepayer . . . .” (79 Cal.P.U.C. 758, 773.)

Seen thus in its full perspective, the transitional procedure adopted by the commission to deal with these overcollections is surely “fair and reasonable.” It is not significantly different from the operation of the “billing account” under the new energy clause, and Edison expressly disavows any challenge to the latter device. For both analytical and legal reasons, it does not constitute retroactive ratemaking.

First, Edison has known from the very beginning that in our state favorable weather conditions inevitably alternate with unfavorable conditions, and hence that any overcollections the company might accumulate via the fuel clause would inexorably be followed by corresponding undercollections which would reduce its fuel collection balance to zero. Numerous witnesses before the commission recognized the existence of such weather cycles in California and their resulting balancing effect on costs and revenues under the fuel clause. Thus William M. Gallavan, PG&E vice president for rates and valuation, explained “there are cyclical changes in the weather conditions, and that is the basis for setting rates heretofore in California.” With respect to variations in precipitation, for example, he noted that it requires an extended period of time “in order to complete the cyclical impact of the hydroelectric generation.” John E. Johnson, supervising utilities engineer for the commission, went into further detail. He stated that because of these weather cycles, over- and undercollections pursuant to the fuel clause will balance out “given enough time.” When asked if 30 or 40 years might be required for this purpose, he replied in the negative; based,on his experience, it was unlikely in his opinion “that it would take as much as 10 years for the self-contained balancing process to work itself out with the present clause.” The witness subsequently explained that over an appropriate time span the probabilities of favorable and unfavorable nonaverage weather conditions are “about equal,” and that it is inherent in the concept of average-year ratemaking in California that “over a long haul the company or the utility is made whole solely by reason of changing weather circumstances.”

This view is supported not only by the record but by Edison itself. In its petition to this court Edison recognizes that the commission has traditionally made “the valid historical assumption” that “over a period of years variations from historical average weather conditions will balance out.” And the same petition argues that if the weather cycle were allowed to run its course the present overcollections would likewise be balanced out: abnormally wet and warm conditions created this “temporary differential,” Edison asserts, “and it is only the Commission’s own decision to shift from an average-year forecast method to a recorded method that will prevent the averaging out of the effect of weather conditions on the revenue-expense differential in the long run.” (Italics added.)

It follows from Edison’s own words that if the commission had allowed the current weather cycle to run its course, all overcollections would have been absorbed during nonaverage dry and cool years by Edison’s greater fuel expenses, and the company’s total dollar benefit from operation of its fuel clause would ultimately have been nil. The point was succinctly made by a dissenting commissioner in the proceedings below: although deeming the 36-month billing credit order to be retroactive ratemaking, that opinion concluded: “It does not follow from the above that we are powerless to prevent Edison from reaping a windfall. One way open is simply to maintain the average year forecast fca [fuel cost adjustment] until a complete weather cycle has occurred. In this way, the above-average wet years will be offset by below-average wet years in time.” (— Cal.P.U.C. —, — (Dec. No. 86085, p. 4) (dis. opn. by Comr. Sturgeon).)

What the commission has done by adopting the present fuel collection balance procedure is simply to choose “another way” of preventing Edison from reaping the same windfall—a way which substitutes a definite credit period of three years in lieu of awaiting the natural completion of the current weather cycle, an event of uncertain date but statistically inevitable occurrence. Inasmuch as the two methods achieve the identical result—a final balancing of fuel clause over- and undercollections—and Edison itself embraces the former, the commission rightly concluded that it has not subjected Edison to retroactive ratemaking by choosing the latter because of a perceived need to institute the new energy clause without delay. Indeed, in view of the same weather cycle Edison cannot fairly complain that it has suffered the disruptive financial consequences of true retroactive ratemaking as exemplified by Pacific Tel. & Tel. and City of Los Angeles I: in the long run Edison admittedly had no expedition of retaining its present fuel clause surplus, and even in the short run it could not reasonably have relied on the use of that surplus because it must have known that in California drought can occur at any time.

Secondly, we do not write on a clean slate in this case. That the foregoing procedure does not constitute retroactive ratemaking within the meaning of Pacific Tel. & Tel. and City of Los Angeles I is demonstrated by our decision in City of Los Angeles v. Public Utilities Com. (1975) 15 Cal.3d 680 [125 Cal.Rptr. 779, 542 P.2d 1371] (hereinafter City of Los Angeles IT). For present purposes we need not repeat in detail the complicated histoiy of that litigation. (See id. at pp. 684-690; City of Los Angeles I, supra, 1 Cal.3d at pp. 336-340; City and County of San Francisco v. Public Utilities Com. (1971) supra, 6 Cal.3d 119 (hereinafter City & County of San Francisco).) It will be sufficient to recall the operative facts and our rulings insofar as here relevant.

Briefly, when a regulated utility switches from the “straight-line” to an “accelerated” method of depreciation for federal tax purposes, an immediate tax saving results. Under the procedure called “accelerated depreciation with flow-through,” that saving is passed on to the ratepayers: the utility pays its taxes on the basis of accelerated depreciation, and the rates are lowered because no more than the actual tax expense incurred is recovered from the ratepayers as a cost of service. Under the procedure called “accelerated depreciation with normalization,” however, the tax saving is retained by the utility: the company still pays its taxes on the basis of accelerated depreciation, but the commission computes the taxes which would have been imposed if the straightline method had been used and permits the utility to recover that higher amount in the rates. The difference between the latter amount and the actual tax expense is set up on the utility’s books as a reserve account for “deferred taxes.” (City of Los Angeles I, supra, 7 Cal.3d at pp. 338-339 & fn. 3.) In practice, however, such taxes never materialize: because the utility’s level of investment in a new plant typically equals or exceeds plant retirement, new depreciation deductions are continuously generated and the tax “deferral” in effect becomes permanent. In such circumstances not only are the ratepayers charged for tax expenses which the utility will never have to pay, but the balance in the reserve account is thus transformed into a capital asset of the utility upon which it can earn interest or, if invested in plant, a return from the ratepayers. (City of Los Angeles II, supra, 15 Cal.3d at pp. 686-687, 690 & fn. 18.)

Prior to 1969 all utilities except Pacific Telephone and Telegraph Company and General Telephone Company of California used accelerated depreciation with flow-through; the latter two continued to use straight-line depreciation. In 1969 the federal tax law was amended to provide that utilities which had not theretofore adopted accelerated depreciation could do so thereafter only with normalization. The two telephone utilities subsequently switched to accelerated depreciation with normalization, and began accumulating the “reserves” described above. In City & County of San Francisco we annulled a commission decision which failed to consider possible ways of preventing the telephone utilities from keeping this windfall. “By permitting Pacific to include in its costs a charge for federal taxes greatly in excess of its actual federal tax expense,” we reasoned, the commission in effect forced the ratepayers to contribute capital to the telephone system—a result wholly at odds with basic principles of ratemaking. (6 Cal.3d at p. 129.) Accordingly, we directed the commission to examine afresh all lawful alternatives for dealing with these “reserves.” (Id. at pp. 130-131.)

Among the alternatives was a procedure which the commission thereafter ruled it had no legal authority to adopt: the annual adjustment clause. In City of Los Angeles II we Addressed that question, and unanimously held the commission had the power to employ such a remedy. We began by explaining the operation of the adjustment clause: “the rate established by the commission includes a formula which, when applied each year to figures in the utilities’ accounts, produces appropriate adjustments in rates, to keep them in step with the company’s changing financial situation. In the case of annual adjustment to reflect the growing deferred tax reserves, the actual amount of the reserve accumulated by the utility would be compared with the amount used in the test year on the basis of which the commission set rates. As the reserve grew, the formula would effect a corresponding reduction in the rate base to take account of this new source of investment capital.” (Fns. omitted.) (15 Cal.3d at p. 691.)

We then emphasized the difference between a true ratemaking proceeding, in which many variables are taken into account and broad policies are formulated, and the narrowly restricted and semi-automatic functioning of an adjustment clause: “The effect of annual adjustment in some respects resembles that which would occur if the commission each year conducted a new rate proceeding in which all factors except that of tax reserve held constant. In such a case the commission would look to the tax reserve as the sole relevant variable and reduce the rate base to compensate for tax reserve accumulations. As long as the commission’s policy towards the tax reserve accumulations remained unchanged, however, such yearly proceedings would reduce themselves to substantially ministerial steps.” (Italics added; fn. omitted.) (Id. at pp. 691-692.) In a footnote at this point (fn. 25) we identified the steps in question: “the regulatory commission’s primary function should be to gather empirical data periodically on changes in each utility’s tax reserve accumulations and then apply relevant data to the adjustment formula.”

The relevance of City of Los Angeles II to the issue at hand is not a matter of speculation: throughout the opinion in that case we relied expressly on the analogy between a tax expense adjustment clause and a fuel cost adjustment clause. For example, after the foregoing explanation of the essentially “ministerial” operation of tax adjustment clauses, we continued: “In similar circumstances the commission has concluded that the promulgation and periodic application of an adjustment formula more efficiently implements its policy. [H] The commission thus employs adjustment clauses when it encounters an item of expense or revenue which tends to vary abnormally in comparison to the utility’s other financial data; fuel cost adjustment clauses, which the commission presently inserts in the tariffs of power companies, constitute a prominent current use of such clauses. The commission’s staff experts testified that the rapidly accumulating tax reserves presented an anomalous factor in the telephone companies’ financial profile similar to that posed by the fuel costs of the power companies.” (Fn. omitted; id. at p. 692.)

The commission nevertheless refused to consider adopting a tax adjustment clause because it believed that Public Utilities Code section 728 (fn. 2, ante) compels a full hearing before each application of an adjustment formula. Section 728, of course, is the statutory foundation for the hearing requirement in true ratemaking proceedings. We held that no such hearing is necessary each time the commission modifies the existing rate base by operation of an adjustment clause. After referring again to the commission’s longstanding use of fuel clauses, we concluded: “the purpose behind the hearing requirement of section 728 demonstrates the permissibility of the annual adjustment scheme here at issue. The purpose of the hearing is to air the policy considerations behind various rate proposals and to establish controverted facts; as the commission’s experience with fuel clauses has shown, a hearing serves no purpose when the only business at hand is the application of a mathematical formula to a figure definitively established by reference to the utilities’ books. The legislative purpose behind section 728 is better served by a plenary consideration of the advantages and disadvantages of an annual adjustment clause [i.e., at the time that clause is adopted in a true ratemaking proceeding] than by a yearly charade attendant to its application.” (Id. at p. 697.)¹⁹

Thus although section 728 requires a hearing in every true ratemaking proceeding, City of Los Angeles II teaches that a hearing is not required each time the rate base is changed by application of an adjustment clause; it follows that in ordering such adjustments the commission is not engaged in ratemaking.. The reasoning applies equally to the decision under review,²⁰ and it leads to the conclusion that in authorizing Edison every few months to adjust its rates by operation of the fuel clause the commission was not engaging in ratemaking. Because the increased charges thus imposed were not the products of ratemaking, they were not rendered inviolable by the rule against retroactive ratemaking. To put it another way, the commission’s decision to further adjust those rates so as to compensate for substantial past overcollections may well be retroactive in effect, but it is not retroactive ratemaking.21

An additional proof of this fact appears in the dispositive portions of our decision in City of Los Angeles II. We there proposed alternative methods by which the telephone utilities could be prevented from benefiting from the collection of rates which, although lawful, were higher than necessary because they had made provision for tax expenses that did not materialize. Among those alternatives, we advised the commission that it could compensate for such past overcollections by the device of reducing the utilities’ rates of return in the future: “the commission could choose to mitigate the ‘windfall’ accruing to [the utilities] in consequence of their failure to elect accelerated depreciation prior to 1969, by setting more modest rates of return in recognition of the additional source of capital' available to the utilities by virtue of the federal tax laws.” (Italics added.) (15 Cal.3d at pp. 704-705, fn. 42.)²²

Again the reasoning is applicable here,²³ and it fully supports the commission’s decision to likewise “mitigate the windfall” in the case at bar by adjusting Edison’s rates in the future so as to offset its past overcollections for fuel expenses which did not materialize. Surely our unanimous opinion in City of Los Angeles II would not have advised the adoption of an illegal procedure; and the conclusion is inescapable that if our proposal therein did not constitute retroactive ratemaking, neither does the commission’s action here.

The decision is affirmed.

Wright, J.,* Elkington, J.,† and Sims, J.,‡ concurred.

1 The Public Utilities Commission and its predecessor, the California Railroad Commission, had long before recognized and applied the rule against retroactive ratemaking. (See, e.g., Re Pacific Tel. & Tel. Co. (1949) 48 Cal.P.U.C. 823, 836-837, and cases cited.)

2 Section 728 provides in pertinent part that “Whenever the commission, after a hearing, finds that the rates . . . collected by any public utility for or in connection with any service . . . are insufficient, unlawful, unjust, [or] unreasonable . . . the commission shall determine and fix, by order, the just, reasonable, or sufficient rates ... to be thereafter observed and in force.” .

3 Pacific Tel. & Tel. relied on a number of decisions of federal courts and our sister states which likewise held that rate-fixing orders could operate only prospectively. (62 Cal.2d at pp. 650-652.) But an examination of each shows that all involved various types of general rate orders and none remotely resembled the situation now before us.

4 To give an idea of scale, we note that at the level of Edison’s operations prevailing when the fuel clause was adopted a difference of .001 cent per kilowatt-hour represented approximately $460,000. (Id. at p. 186.)

5 For the theory and practice of fuel clauses generally, see Schiffel, Electric Utility Regulation: An Overview of Fuel Adjustment Clauses (1975) 95 Pub. Util. Fort. No. 13, page 23; Sarikas, What is New in Adjustment Clauses, id at page 32; Trigg, Escalator Clauses in Public Utility Rate Schedules (1958) 106 U.Pa.L.Rev. 964; Comment, The Fuel Adjustment Clause audits Role in the Regulatory Process (1976) 47 Miss.L.J. 302.

6 This reading is verified by a further finding in the decision, in which the commission declared the fuel clause would not be inflationary because “any price increases brought about by use of the fuel clause merely reflect the effect of past price inflation on the costs of fuel.” (Ibid.)

7 Again and again the witness used similar language in describing Edison’s understanding of the intent of the fuel clause. Thus he replied as follows to cross-examination by a deputy city attorney of the City of San Diego:

“Q. Now, the purpose as I understand it, of the fuel clause adjustment is to insure that the difference between revenues and expenses come[s] out even; isn’t that true? A. I don’t

think I could characterize it that way.

“Q. Would you characterize it? A. I think as I’ve characterized earlier in my testimony and my cross-examination, the fuel clause was a device that was put into Edison’s tariff ■schedules to help minimize or to offset any decay■ in the rate of return that would otherwise occur due to changes in the fuel and purchased power pricing mix that were being experienced by the company.” (Italics added.)

8 Edison’s misconception also underlies its contention that it is entitled to keep these overcollections because during the years in question its actual rate of return averaged less than the minimum reasonable rate previously authorized by the commission. The contention fails for two reasons. First, as noted above, Edison was not entitled to earn a profit on its expenses. Second, even its lawful profit was not guaranteed. A utility is entitled only to the opportunity to earn a reasonable return on its investment; the law does not insure that it will in fact earn the particular rate of return authorized by the commission, or indeed that it will earn any net revenues. (Power Comm’n v. Pipeline Co. (1942) 315 U.S. 575, 590 [86 L.Ed. 1037, 1051-1052, 62 S.Ct. 736]; Bluefield Co. v. Pub. Sen. Comm’n (1923) 262 U.S. 679, 692-693 [67 L.Ed. 1176, 1182-1183, 43 S.Ct. 675]; Re Gen. Tel. Co. of Cal. (1969) 69 Cal.P.U.C. 601, 610; Oakland v. Key System Transit Lines (1953) 52 Cal.P.U.C. 779,786.)

9 Office of the Auditor General, Report on Adjustment of Electric Rates for Fuel Cost Changes (Aug. 1975) at page 4 (hereinafter called Auditor General’s Rep.).

10 A secondary reason was above-average temperatures during the same seasons, causing a substantial decrease in the demand for natural gas for heating purposes and a concomitant increase in its availability for generating electricity. Natural gas is a cheaper fuel than oil.

11 This position drew the following reaction from the commission examiner: “if we isolate the fuel cost revenues in.a separate [adjustment] proceeding, why would you not isolate the revenue that you received thereafter? You want to obtain the revenues in an isolated fashion to avoid the regulatory lag but you do not want to account for those revenues in an isolated fashion. I think that is totally inconsistent.”

12 Southem California Edison Company, Annual Report to Shareholders (1974) page 12 (hereinafter called Annual Rep.).

13 In the latter report, introduced as an exhibit in the proceedings before the commission, the congressional subcommittee declared it was “dismayed by the frequency in which fuel clauses have enabled utilities to bill consumers for fuel costs that were never incurred.” (Id. at p. 6.) The report then singled oiit Edison as having “boasted of its profit-making fuel clause,” and rejected Edison’s rationale that “it is proper for a utility to overcollect through the operation of its fuel clause, provided the company’s overall earnings do not exceed its authorized rate of return. Such a view would seem to contradict the industry’s oft repeated assurances concerning the neutral effects of fuel clauses.” (Id. at p. 7.) For these and other reasons the subcommittee found that “fuel adjustment clauses, in any form, are unwise, unnecessary, unworkable, and unfair” (id. at p. 1), and concluded that such clauses “should be abolished except during limited emergency periods. Even in such situations, all fuel adjustment clause charges should be subject to a prompt commission audit and refund with interest.” (Id. at p. 3.)

14 The investigation inquired into the fuel cost collection practices of Pacific Gas and Electric Company (PG&E), San Diego Gas and Electric Company (San Diego), and Sierra Pacific Power Company (Sierra Pacific), in addition to Edison. The resulting decision of the commission affects all four utilities, but only Edison has sought judicial review.

15 A clause so designed, of course, eliminates all reliance on forecasts of weather conditions 12 months in advance, which the commission found to be both “inaccurate and unreliable” in the present state of the art.

16 There is nothing novel about a fuel or energy clause which operates on actual recorded data. PG&E proposed such a provision in the proceedings originally leading to its own fuel clause. (Re Pacific Gas & Electric Co. (1973) 74 Cal.P.U.C. 781, 786.) The fuel clause of Sierra Pacific has been based on recorded data since its inception four years ago. (Re Sierra Pacific Power Co. (May 8, 1973) Dec. No. 81355.) And on a nationwide scale, fuel clauses in all tariffs under the jurisdiction of the Federal Power Commission now operate on recorded data (18 C.F.R. § 35.14 (1975)), as do the majority of such clauses authorized by state regulatory agencies (see Trigg, Escalator Clauses in Public Utility Rate Schedules (1958) 106 U.Pa.L.Rev. 964, 976-979).

17 According to Edison’s figures filed with the commission in compliance with the decision under review, Edison’s net fuel clause overcollections amounted to $133,241,000, as of April 30, 1976. The total fuel collection balance for all three major utilities exceeded $200 million. Sierra Pacific experienced a small undercollection in the operation of its fuel clause.

18 PG&E’s expert witness characterized this as “the conversion factor, which, would be a downward adjustment in the fuel cost adjustment that would otherwise be in effect.”

19 For similar reasons we went on to hold that although a prior opportunity to be heard is also required by the due process clause in a true ratemaking proceeding, the Constitution does not compel such an unnecessary step before each subsequent application of an adjustment formula adopted in that proceeding. (Id. at pp. 697-703.)

20 It is trae that City of Los Angeles II authorized the use of a clause designed to adjust the rate base (id. at p. 691) to reflect the utilities’ changing financial situation, while the fuel clause in the case at bar operated by means of a billing factor which had the effect of adjusting the rates. But the distinction is without practical effect: because one element of the rates is a return on the rate base, a sufficient change in the latter will produce a corresponding change in the former. The same result can thus be achieved by appropriate adjustments to either.

21 Thus the commission was correct in formally finding that the rates fixed by operation of the fuel cost adjustment clause were not “general rates” but “extraordinary rates not created by or in a general rate proceeding”; and it was equally correct in concluding therefrom that “The future reduction of fuel clause adjustment rates is not retroactive ratemaking,” even though designed “to reflect past over- or undercollections.” (79 Cal.P.U.C. 758,772,773.)

22 That this was not an ill-considered dictum is shown by the fact that we reiterated the proposal in our judgment. (Id. at p. 708.)

23 Because of the interdependence of rate base, rate of return, and rates (see fn. 20, ante), there is no essential difference between offsetting past overcollections by adjusting future rates, as the commission did in the case at bar, and reaching the same result by adjusting future rates of return, as we said it could do in City of Los Angeles II.

Retired Chief Justice of California sitting under assignment by the Acting Chairperson of the Judicial Council.

Assigned by the Chairperson of the Judicial Council.

Retired Associate Justice of the Court of Appeal sitting under assignment by the Chairperson of the Judicial Council.