City of Port Neches, City of Nederland, City of Groves, and Texas Gas Service Company v. Railroad Commission of Texas

TEXAS COURT OF APPEALS, THIRD DISTRICT, AT AUSTIN

NO. 03-05-00777-CV

City of Port Neches, City of Nederland, City of Groves, and Texas Gas
Service Company, Appellants

v.

Railroad Commission of Texas, Appellee

FROM THE DISTRICT COURT OF TRAVIS COUNTY, 201ST JUDICIAL DISTRICT
NO. GN403320, HONORABLE SUZANNE COVINGTON, JUDGE PRESIDING

OPINION

This appeal arises from the district court’s affirmance of a final order entered by the

Railroad Commission awarding an increase in Texas Gas Service Company’s (“TGS’s”) gas rates

for three of the four cities comprising the South Jefferson County Service Area (“SJC service

area”)—the Cities of Port Neches, Nederland, and Groves.1 Appellants include the Cities and TGS,

a gas utility that is subject to the Gas Utility Regulatory Act. See Tex. Util. Code Ann. § 101.003(7)

(West Supp. 2005); § 101.006(b) (West 1998). Although the Cities and TGS both challenge the

district court’s affirmance of the Commission’s final order, they take opposing positions.

Essentially, the Cities raise two issues arguing that the awarded rate increase was too high, while

1
We refer to these three cities, collectively, as “Cities.” The fourth city in the SJC service
area is Port Arthur, which did not participate in the proceedings at-issue because it entered a
settlement agreement with TGS concerning its gas rates.
TGS raises two contrary issues arguing that the awarded rate increase and rate case expenses were

too low. We will affirm in part and reverse and remand in part.

BACKGROUND

On November 15, 2002, Southern Union Gas (a predecessor of TGS) requested an

annual rate increase of $853,761 for all four cities in the SJC Service Area. This requested increase

was based on test-year data ending in March 2002. The test-year data was systemwide, meaning that

it was compiled for all four cities in the SJC service area. Southern Union published a public notice

of the $853,761 requested rate increase. The notice was posted in a local newspaper of general

circulation from November 30 until December 30, 2002. See id. §§ 104.102-.103 (West 1998).

Southern Union’s Texas division was then bought by ONEOK Corporation. Texas

Gas Service (TGS), as a division of ONEOK, took over the operations of the SJC service area

beginning in January 2003. TGS continued the negotiations begun by Southern Union regarding the

rate increase in the SJC service area.

In March 2003, TGS and the City of Port Arthur entered into a settlement agreement

whereby Port Arthur agreed to pay the increased rates requested by TGS in exchange for the

inclusion of a “most favored nation” clause in the settlement agreement. This clause provided that

if any of the remaining cities in the SJC service area obtained lower rates, Port Arthur would receive

the benefit of those rates.

In April 2003, TGS and the remaining cities in the SJC service area—the Cities of

Port Neches, Groves, and Nederland—mediated an agreement whereby TGS would file an updated

2
rate request to reflect the costs arising from ONEOK’s/TGS’s acquisition of Southern Union.2 The

agreement expressly stated that the updated filing would be considered as part of a “hearing in

progress,” rather than a new request.

Pursuant to the mediated agreement, on June 27, 2003, TGS filed an updated rate

request with the Cities based on a systemwide test year ending December 31, 2002. The updated

request reflected that TGS could justify an increase of $1,013,007, but would seek an increase of

$853,761 from the Cities, which was the original amount of increase sought by Southern Union in

November 2002.3 On appeal, the Cities characterize this updated filing as a “waiver” by TGS of any

amount above $853,761. TGS and the Commission, on the other hand, urge that the company’s

limited request was merely a settlement offer made in attempt to expediently conclude the

proceedings and that, rather than having waived the higher amount, TGS preserved its right to later

seek the full increase if the Cities refused its $853,761 offer. TGS did not publish a revised public

notice when it filed its updated rate request.4 Each of the Cities denied TGS’s requested rate increase

in full.

2
Specifically, the agreement directed TGS to file “a supplemental rate package, based on
a test year ending December 31, 2002, adjusted for known and measurable changes, and supporting
the rates proposed by TGS in its original filing with the Cities of November 15, 2002, or such
modifications to those rates as TGS shall then deem appropriate.”
3
In the cover letter attached to its June filing, TGS stated, “Although the supplemental rate
filing reflects a deficiency that is [] greater than the original, the Company does not, at this time, seek
recovery of the additional deficiency. The proposed tariffs included in this package reflect rates
which would result in [the same] increase we originally requested.”
4
The hearing examiners observed in the proposal for decision (PFD) that “the fact that
multiple filings were made” has “caused considerable confusion” and raised unique “jurisdictional
issues.”

3
 On November 12, 2003, TGS appealed the Cities’ decision by filing a petition for

review with the Commission. See Tex. Util. Code Ann. § 103.054 (West 1998). In its petition, TGS

sought a rate increase of $1,225,857 from the Commission, which was based on the updated test-year

data ending December 31, 2002, adjusted for known and measurable changes. See id. § 103.055

(West 1998). In other words, the requested amount sought by TGS in its petition for review was the

higher amount set forth in its June 27 updated filing ($1,013,007) plus $212,850 for changes that had

occurred since that filing. The Cities intervened in the proceeding, requesting that the Commission

decrease TGS’s existing rates by $253,057. Following a four-day hearing, the examiners issued a

proposal for decision (PFD) on June 15. The Commission adopted most of the examiners’

recommendations in its final order, which awarded TGS a rate increase of $887,295.

Following unsuccessful motions for rehearing, both the Cities and TGS sought

judicial review of the Commission’s final order in district court. See Tex. Gov’t Code Ann.

§§ 2001.171-.178 (West 2000); Tex. Util. Code Ann. § 105.001 (West 1998). The district court

affirmed the Commission’s order. This appeal followed.

In opposing issues, both the Cities and TGS assert that the district court erred in

affirming the Commission’s order. Specifically, the Cities argue that (1) the awarded rate increase

was in excess of the Commission’s jurisdictional limits because the Commission improperly

considered the expenses of the Southern Union acquisition as a “known and measurable change,”

and (2) the rate calculation should have included as a “known and measurable change” the $295,160

worth of increased revenues that TGS would collect from Port Arthur pursuant to the settlement

agreement. TGS disagrees with the Cities on both of these issues and asserts in two additional issues

4
that (1) the rate calculation should not have included as “revenues” $44,239 worth of “forfeited

discount revenues” that TGS may collect from Port Arthur, and (2) the Commission should have

awarded TGS $80,480 in rate case expenses for the cost of a consultant who prepared data and

testified for TGS. The Commission responds that all of the Cities’ and TGS’s issues are without

merit and urges that the district court correctly affirmed the Commission’s final order. We will

consider each of these issues as follows: (1) jurisdictional limits, (2) increased settlement revenues,

(3) forfeited discount revenues, and (4) rate case expenses.

STANDARD OF REVIEW

We review an order of the Railroad Commission in a ratemaking proceeding for

substantial evidence. Tex. Gov’t Code Ann. § 2001.174 (West 2000); Tex. Util. Code Ann.

§ 105.001; Railroad Comm’n v. WBD Oil & Gas Co., 104 S.W.3d 69, 75 & n.44 (Tex. 2003);

CenterPoint Energy Entex v. Railroad Comm’n, No. 03-04-00688-CV, 2006 Tex. App. LEXIS 3518,

at *9 (Tex. App.—Austin Apr. 28, 2006, no pet.). Under this standard, we presume that the

Commission’s findings are supported by substantial evidence, and the contestant bears the burden

of proving otherwise. Reliant Energy, Inc. v. Public Util. Comm’n, 153 S.W.3d 174, 184 (Tex.

App.—Austin 2004, pet. denied). The Commission’s order may be reversed only if a party’s

substantial rights have been prejudiced because the administrative decisions (1) violate a

constitutional or statutory provision, (2) exceed the agency’s authority, (3) were made through

unlawful procedure, (4) are affected by another error of law, (5) are not reasonably supported by

substantial evidence when considering the reliable and probative evidence in the record as a whole,

5
or (6) are arbitrary or capricious or characterized by an abuse of discretion. Tex. Gov’t Code Ann.

§ 2001.174.

Although substantial evidence requires more than a scintilla, the evidence may

actually preponderate against the Commission’s decision, and this Court must still uphold it if

enough evidence suggests that the determination was within the bounds of reasonableness, that is,

if substantial evidence supports its determination. Nucor Steel v. Public Util. Comm’n, 168 S.W.3d

260, 267 (Tex. App.—Austin 2005, no pet.). The test is not whether the agency reached the correct

conclusion, but whether some reasonable basis exists in the record to support the agency’s action.

City of El Paso v. Public Util. Comm’n, 883 S.W.2d 179, 185 (Tex. 1994); Occidental Permian Ltd.

v. Railroad Comm’n, 47 S.W.3d 801, 805 (Tex. App.—Austin 2001, no pet.). Although the record

may contain conflicting evidence, credibility is lent to the Commission’s ultimate resolution of those

conflicts when, as here, “the record, evaluated as a whole, reflects a process of discussion, careful

consideration, and compromise.” Pedernales Elec. Coop. v. Public Util. Comm’n, 809 S.W.2d 332,

341 (Tex. App.—Austin 1991, no writ). We may not substitute our judgment for that of the agency

on questions committed to agency discretion. CenterPoint Energy, 2006 Tex. App. LEXIS 3518,

at *10 (citing Gulf States Utils. Co. v. Public Util. Comm’n, 947 S.W.2d 887, 890 (Tex. 1997)).

ANALYSIS

Jurisdictional Limits

The Cities complain in their first issue that the rate increase awarded in the

Commission’s final order and affirmed by the district court’s judgment should be reversed because

it exceeds the jurisdictional limits of the Commission’s authority. Specifically, the Cities urge that

6
the appropriate rate increase should have been $728,048, which is $159,247 less than the $887,295

increase awarded by the Commission. The $159,247 represents the expenses incurred by

ONEOK/TGS from the acquisition of Southern Union. The Cities contend that these expenses

cannot be included as a “known and measurable change.” Both the Commission and TGS respond

that it was proper to include the $159,247 in the rate calculation and, hence, the awarded rate

increase was within the Commission’s jurisdictional authority.

The Gas Utilities Regulatory Act (GURA) provides that the Railroad Commission

is responsible for the regulation of gas utilities, such as TGS. See generally Tex. Util. Code Ann.

§§ 102.001-.005 (West 1998 & Supp. 2005). GURA is to be “construed liberally to promote the

effectiveness and efficiency of regulation of gas utilities.” See id. § 101.007 (West 1998);

Centerpoint Energy Entex v. Railroad Comm’n, No. 03-04-00731-CV, 2006 Tex. App. LEXIS 5882,

at *11 (Tex. App.—Austin July 7, 2006, no pet.). The Commission’s authority, however, is not

without limit. The Commission is a creature of statute and has no powers other than those expressly

conferred on it by the legislature or implied as reasonably necessary to fulfill its express functions.

City of Austin v. Southwestern Bell Tel. Co., 92 S.W.3d 434, 441 (Tex. 2002); Railroad Comm’n v.

Lone Star Gas Co., 844 S.W.2d 679, 685 (Tex. 1992).

The rate-setting process for gas utilities within municipal borders begins at the

municipal level. Municipalities have exclusive original jurisdiction over the rates, operations, and

services of a gas utility within a municipality, subject to GURA’s restrictions that the rates be “fair,

just, and reasonable.” Tex. Util. Code Ann. § 103.001 (West Supp. 2005).5 To obtain a rate

5
The Railroad Commission has appellate jurisdiction over these rates and original
jurisdiction to set rates in unincorporated areas, known as “environs.” Tex. Util. Code Ann.

7
increase, a gas utility must file a request with the municipality (a “statement of intent”) and publish

a public notice of that intent for four consecutive weeks in a local newspaper. Id. §§ 104.102-.103.

If the gas utility is dissatisfied with the municipality’s decision about the rate request, it may appeal

to the Commission. Id. § 103.051 (West 1998).

Section 103.055(a) provides that an appeal to the Commission of a requested rate

filing shall be “de novo and based on the test year presented to the municipality adjusted for known

changes that are measurable with reasonable accuracy.” Id. § 103.055(a) (West 1998). In other

words, the Commission is to determine, based on the information presented to the municipality, what

rate the municipality should have set, and then increase or decrease that amount based on the known

and measurable changes that have occurred since the test-year data was collected. Id. Additionally,

the Commission must ensure that the rates are just and reasonable, and not unreasonably preferential,

and that the rates “permit the utility a reasonable opportunity to earn a reasonable return,” while not

“yield[ing] more than a fair return.” Id. §§ 104.003-.004, .051-.052 (West 1998); CenterPoint

Energy, 2006 Tex. App. LEXIS 3518, at *11.

Here, all parties agree that, pursuant to section 103.055(a), the Commission’s proper

method of calculating the necessary rate change on appeal is to start with the total test year presented

to the Cities and then adjust that amount for known and measurable changes. See Tex. Util. Code

Ann. § 103.055(a). The dispute about whether the awarded rate increase was excessive turns on a

§ 102.001 (West Supp. 2005), § 103.055 (West 1998). Also, a municipality can surrender its
authority to the Commission. Centerpoint Energy Entex v. Railroad Comm’n, No. 03-04-00731-CV,
2006 Tex. App. LEXIS 5882, at *3 n.3 (Tex. App.—Austin July 7, 2006, no pet.) (citing Tex. Util.
Code Ann. §§ 102.001(a)(1)(B), 103.001, 103.003 (West Supp. 2005)).

8
disagreement about whether the expenses of the acquisition should have been included as a “known

and measurable change.” See id. The Commission has discretion over what adjustments to make

for known and measurable changes. Central Power & Light v. Public Util. Comm’n, 36 S.W.3d 547,

563 (Tex. App.—Austin 2000, pet. denied). Thus, in reviewing the Commission’s order, we

presume that there is substantial evidence in the record to support the Commission’s calculation of

known and measurable changes, but we must determine if its decision was in violation of the statute,

in excess of its statutory authority, or was arbitrary and capricious or characterized by an abuse of

discretion. See Reliant Energy, 153 S.W.3d at 184; City of El Paso, 883 S.W.2d at 185.

To understand the parties’ arguments, it is necessary to examine and compare their

specific calculations. The Cities contend that the rate increase should have been calculated as

follows. Begin with $853,761—which is the amount that was originally requested and publicly

noticed by Southern Union in November 2002 and was then requested again by TGS in June 2003.

Increase that amount by $212,849 for “known and measurable changes” that occurred between

TGS’s June 2003 updated rate filing and its November 2003 petition for review. This equals

$1,066,610, which (according to the Cities) is the total amount that was properly before the

Commission. Then, decrease that total by $338,562 to reflect the “cost of service adjustments” made

by the Commission. This results in a rate increase of $728,048, which is $159,247 less than the

$887,295 increase awarded by the Commission.

The Commission and TGS agree with the Cities that $853,761 was the appropriate

starting figure6 and that an increase of $212,849 was appropriate to account for known and

6
The Commission acknowledged in its final order that, because TGS never published an
updated public notice of a higher amount, the maximum rate increase that the Cities could have

9
measurable changes occurring after June 2003. The Commission and TGS, however, disagree with

the Cities about whether an additional increase should be included.

Whereas the Cities seek to limit the increase to changes that occurred after TGS’s

June 2003 filing (i.e., $212,849), the Commission and TGS urge that, in addition to this amount, the

starting figure should also be increased by the “known and measurable change” of $159,247 to

reflect the expenses associated with ONEOK’s/TGS’s acquisition of Southern Union. The

Commission and TGS contend that these expenses are supported by the data presented in TGS’s June

2003 updated filing. They argue that—although TGS voluntarily limited its request to $853,761 at

that time and, therefore, did not publish notice of the higher amount—the updated filing presents

data from which to calculate with reasonable accuracy an additional $159,247 in known and

measurable changes.7 Therefore, the Commission and TGS urge that the total amount properly

before the Commission was $1,225,856 (the sum of $853,761 + $212,849 + $159,247).

The Cities do not contest that TGS incurred expenses of $159,247 from the

acquisition or that the June 2003 filing supported these expenses. Rather, the Cities argue that (1)

TGS waived the recovery of these expenses by not seeking the full amount ($1,013,007) from the

Cities and not publishing an updated public notice of that amount and that, (2) in any event, the

Commission is authorized by GURA to consider only the known and measurable changes that arose

approved was $853,761—the amount requested in the original November 2002 filing, published in
the public notice, and reasserted in the updated June 2003 filing. See Tex. Util. Code Ann.
§§ 104.102-.103 (West 1998).
7
It is undisputed that TGS demonstrated in its June 2003 filing that it could justify an
increase of $1,013,007, but sought only $853,761—a difference of $159,246. It is unclear why this
amount is one-dollar different than the amount discussed by the Cities. For clarity, we will refer to
the disputed amount as $159,247.

10
after the rate request was filed with the municipalities; any changes existing at the time the request

was before the Cities must be disregarded. We disagree.

The statute expressly entitles the Commission to review the municipal decision de

novo, as long as the Commission begins with the test year that was presented to the municipality and

publicly noticed, and adjusts it “for known changes that are calculable with reasonable accuracy.”

See Tex. Util. Code Ann. §§ 103.055(a), 104.102-.103. The Cities attempt to limit the statute’s

express grant of de novo review by isolating the statute’s language that the Commission is to

“establish[] the rates . . . the municipality should have set.” See id. § 103.055(b). On this basis, the

Cities urge that the Commission is prohibited from awarding any rate increase greater than the

amount presented at the municipal level. This argument is without merit. The statute plainly allows

the Commission to award a rate increase greater than the request made at the municipal level because

that amount may be adjusted for known and measurable changes, which allows an upward

adjustment. See id.

Here, it is undisputed that the Commission’s proper starting figure was $853,761 (the

amount presented to the Cities and publicly noticed) and that an increase of $212,849 was

appropriate for expenses arising after June 2003. The record further reflects that TGS incurred

additional known and measurable expenses of $159,247 due to the January 2003 acquisition of

Southern Union, which occurred after the close of the December 2002 test year that was presented

to the Cities. Moreover, by their mediated agreement with TGS, the Cities had expressly directed

TGS to update its filing to demonstrate “a supplemental rate package, based on a test year ending

December 31, 2002, adjusted for known and measurable changes, and . . . [including] such

11
modifications to those rates as TGS shall then deem appropriate.” TGS followed the Cities’

directive and submitted an updated filing that reflected additional expenses based on the 2003

acquisition of Southern Union, which occurred after the test year ended, and these expenses were

calculable with reasonable accuracy based on the data presented in TGS’s updated filing. Nothing

in the statute prohibits the Commission from accounting for these expenses as a “known and

measurable change” simply because they were known to TGS at the time of its updated request. See

id. § 103.055. Rather, the supreme court has recognized that, because future rates are set on the basis

of past costs, it is necessary to account for changes occurring after the test-year period “to make the

test-year data as representative as possible of the cost situation that is apt to prevail in the future.”

Suburban Util. Corp. v . Public Util. Comm’n, 652 S.W.2d 358, 366 (Tex. 1983) (citations omitted).

Also, in City of Amarillo v. Railroad Commission, this Court rejected an argument

similar to the one asserted by the Cities. 894 S.W.2d 491 (Tex. App.—Austin 1995, writ denied).

There, Amarillo argued “that the Commission’s appellate jurisdiction is limited to ‘fixing such rates

that the municipality should have fixed’” and that, based on this limitation, the Commission erred

in re-examining Amarillo’s award of rate case expenses. Id. at 494. This Court disagreed, holding

that Amarillo’s interpretation “violates fundamental tenants of statutory construction” and that the

Commission’s “broad grant of jurisdiction to review all municipality orders, coupled with its

authority to conduct appeals de novo” permitted the Commission to re-examine and re-formulate

Amarillo’s rate calculation. Id. at 494-95. The Commission was not bound to treat the disputed

expenses in the same manner as Amarillo had. Id. at 495 n.1.

12
 Finally, the fact that TGS initially chose to limit its rate request to $853,761 does not

mean that it waived recovery of the additional $159,247 as a “known and measurable change.”

TGS’s Director of Financial and Regulatory Analysis, Stacey McTaggart, testified that TGS “limited

its [June 2003] request to the original amount as a show of good faith in order to settle the case.

[TGS] sincerely desired to settle the case at the city level and tried to demonstrate that desire to the

Cities by not increasing the amount of the requested increase.” In the cover letter attached to its

updated filing, TGS stated that it did not seek the additional increase “at this time,” indicating that

it reserved the right to do so at a later date. TGS was entitled to seek a lower amount in attempt to

settle the negotiations expeditiously, while still presenting data to support the expenses it had

incurred since its November 2002 filing based on the transfer of ownership from Southern Union

to ONEOK/TGS. We decline to adopt a rule that would discourage settlement offers by utilities.

We conclude that the Commission properly included the $159,247 incurred as a result

of ONEOK’s/TGS’s acquisition of Southern Union as a “known and measurable change.” The

resulting total rate increase was, therefore, not in excess of the Commission’s statutory authority.8

Rather, this portion of the Commission’s order was supported by substantial evidence and the district

court did not err in affirming it. The Cities’ first issue is overruled.

8
Alternatively, the Cities’ argument that the awarded increase of $887,295 exceeded the
Commission’s jurisdictional limits is without merit because the Cities acknowledge that the
Commission was authorized to consider a total increase of $1,066,610 (i.e., the originally requested
and publicly noticed $853,761, plus known and measurable changes of $212,849). The Cities’
argument presumes that the $338,562 reduction to that amount made by the Commission somehow
limited the Commission’s jurisdictional authority. This presumption is unfounded. Having
recognized that the Commission could properly consider an increase of over a million dollars, the
Cities cannot now claim that the Commission’s award of $887,295 exceeded its authority.

13
Increased Settlement Revenues

In their second issue, the Cities argue that the rate increase awarded by the

Commission and affirmed by the district court was excessive because the Commission failed to

account for increased revenues that TGS would receive from its settlement with Port Arthur. Both

the Commission and TGS respond that these revenues were properly excluded from the rate

calculation. Again, we review the Commission’s rate calculation decisions for substantial evidence.9

Pursuant to the settlement agreement entered into by TGS and Port Arthur in March

2003, TGS planned to collect approximately $295,160 in additional revenues from Port Arthur. In

its final order, the Commission found that adjusting the rates “by adding [the increased settlement]

revenues from Port Arthur will result in an under recovery by TGS and is not reasonable.” The

Cities argue that, because TGS would collect these increased revenues from Port Arthur, a city

within the SJC service area, the increased revenues must be acknowledged as a known and

measurable change; i.e., an increase to TGS’s income. Further, the Cities assert that it is inequitable

to not credit the increased Port Arthur revenues against TGS’s revenue requirement because, by

9
As an initial matter, because the second and third issues on appeal involve complex rate-
setting calculations, it is helpful to understand the components of the Commission’s rate-setting
formula. Although more simply stated in the first issue as “test year adjusted for known and
measurable changes,” the formula is specifically as follows: Total rate change necessary = (revenue
requirement) – (total adjusted revenues). The revenue requirement is calculated by adding the
utility’s “return on investment” (its rate of return multiplied by its reasonable and prudent capital
investment) to its “reasonable and necessary operating expenses” (the test-year expenses adjusted
for known and measurable changes). The total adjusted revenues are calculated by adjusting the test-
year revenues for known and measurable changes. See Tex. Util. Code Ann. §§ 104.053-.058 (West
1998).

14
filing a rate request based on systemwide costs, TGS received the benefit of the Port Arthur

expenses. We disagree.

The Commission’s decision to not include the Port Arthur settlement revenues as a

known and measurable change was within its discretion and was supported by substantial evidence.

See Central Power & Light, 36 S.W.3d at 563 (Commission has discretion over what adjustments

to make for known and measurable changes). We reject the Cities’ attempt to distinguish Central

Power & Light on the basis that it involved the Public Utility Commission rather than the Railroad

Commission because the Cities acknowledge in their reply brief that “the Commission has the sole

discretion to determine what constitutes a known and measurable change.” The Cities’

disagreement, therefore, is not whether the Commission has such discretion, but instead concerns

the Commission’s exercise of that discretion in this case. The Cities argue that, because “there can

be no question that the . . . Port Arthur settlement [revenues] w[ere] a known and measurable change

of $295,160,” the Commission had no choice but to include them. This argument is without merit

because the collection of that amount was speculative.

The collection of these revenues was subject to the “most favored nations clause”

included in the Port Arthur settlement, which stated that, if any of the three remaining SJC service

area cities obtained lower rates, Port Arthur’s rates would be reduced accordingly. Thus, at the time

of the Commission’s order, the $295,160 reflected only projected revenues that had not yet been

fully collected and were subject to change. Due to the speculative nature of the Port Arthur

settlement revenues, it would have been unreasonable for the Commission to include them as a

“known and measurable change.”

15
 Furthermore, there was no inequity in setting the three Cities’ rates based on

systemwide costs, yet exclusive of the increased Port Arthur settlement revenues, because the test-

year data upon which the rates were calculated accounted for both the expenses and revenues of the

entire SJC service area. The legislature has determined that the most efficient method of setting rates

is to compile data from a historical test year, adjust it for known changes, and then use those figures

to project rates for the future. Tex. Util. Code Ann. § 101.003(16) (West Supp. 2005),

§§ 103.055(a), .056 (West 1998); see also Centerpoint Energy, 2006 Tex. App. LEXIS 5882, at *16.

It is common practice for the test-year data to be collected systemwide rather than on an individual-

city basis because the system operates in an integrated fashion. See City of Corpus Christi v. Public

Utility Comm’n, 572 S.W.2d 290, 295 (Tex. 1978) (“realit[y] in this state is the existence of large

integrated utilities, the facilities of which serve many communities without regard to governmental

boundaries”). The examiners stated in the PFD that, because the “SJC service area is operated as

a single integrated service area, it is not possible to separately identify all of the plant and expenses

associated with the three cities.” This conclusion was supported by the testimony of Stacey

McTaggart, TGS’s Director of Financial and Regulatory Analysis, who explained that the

systemwide approach “is the normal and ordinary way that rates are set when one portion of a service

area has implemented a revenue increase and another portion has not,” such as in “environs cases.”

Additionally, F. Jay Cummins, a senior consultant with R.J. Covington Consulting,

testified on behalf of TGS that it would be “erroneous” to “adjust rates downward” for the increased

settlement revenues because they do “not involve billing determinate changes” and “Port Arthur’s

action has no impact on the rate setting process in this proceeding.” Cummins provided detailed

16
calculations demonstrating why it would create a revenue deficiency for TGS if the increased

settlement revenues were included in the total adjusted revenue calculation.10 Also, McTaggart

testified that, if the increased settlement revenues were included in the calculation, it would

“incorrectly spread[] to the Cities a benefit from the increase paid by customers in Port Arthur,”

thereby “reduc[ing] the revenue requirement of the Cities without making any concomitant changes

to the billing determinants used to set rates in this case.” Accordingly, substantial evidence existed

to support the Commission’s finding that, because the test-year data upon which the rates were

calculated already included Port Arthur revenues, the Cities’ position—of also including the Port

Arthur settlement revenues—would double-count revenues for Port Arthur and would result in an

under-recovery to TGS.

Finally, the issue presented here is similar to one previously decided by this Court in

City of El Paso v. El Paso Electric Co., 851 S.W.2d 896 (Tex. App.—Austin 1993, writ denied).

There, the Commission declined to include in its rate calculation the revenues received by the utility

from “off-system sales.” Id. at 902. El Paso argued that such revenues should have been credited

against the utility’s “known and reasonably predictable” costs. Id. at 903. Noting that the

Commission is given broad discretion over how to calculate revenues, this Court held that the

Commission’s decision to not include “off-system sale revenues” was reasonable and affirmed that

portion of the district court’s judgment upholding the order. Id. at 903-04.

10
In sum, because the “necessary rate change” is calculated by subtracting “total adjusted
revenues” (test-year revenues adjusted for known and measurable changes) from the “approved
revenue requirement” (test-year expenses adjusted for known and measurable changes, plus return
on investment) the Cities’ proposed credit to the amount of revenues would have the overall affect
of lowering the awarded rate increase, thereby creating a revenue shortfall for TGS.

17
 Because the increased settlement revenues from Port Arthur were speculative and

were outside the scope of the test year, we conclude that the Commission’s decision to exclude them

from its rate calculation was not arbitrary and capricious nor characterized by an abuse of discretion.

The Cities’ second issue is overruled.

Having overruled both of the Cities’ issues, we now address the two issues raised by

TGS.

Forfeited Discount Revenues

As part of its initially proposed rate design, TGS had included a “prompt payment

provision” on residential, commercial, and public authority tariffs. Pursuant to this provision, a five-

percent penalty would be added to any bill not paid within fifteen days of its issuance. The revenues

that would result from such payments are referred to as “forfeited discount revenues, (FDRs),”

because they are incurred by customers who “forfeit the discount” by not paying their bill within the

initial fifteen days. The Commission found in its final order that the prompt payment provision was

an improper penalty disallowed by the Commission’s “quality of service rules.” See 16 Tex. Admin.

Code § 7.45 (2004). The Commission, therefore, eliminated the provision, which in turn eliminated

TGS’s ability to recover the FDRs. The Commission’s order, however, applied only to the revenues

collected in Port Neches, Nederland, and Groves because Port Arthur had agreed to pay higher rates

pursuant to the separate settlement agreement. The prompt payment provision and resulting FDRs

were part of the settled rate established between Port Arthur and TGS, which had not been appealed

to the Commission. Therefore, in Port Arthur, TGS continued to enforce the prompt payment

provision and collect the resulting FDRs. In its rate calculation, the Commission eliminated the

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FDRs relating to the Cities, but maintained the Port Arthur FDRs as a revenue credit. In its first

issue, TGS complains about this decision, urging that it resulted in an under-recovery of rates.

As indicated in TGS’s original application, the total systemwide amount to be

collected from the FDRs was $180,492, which was included in TGS’s calculation of total revenues.

The Commission allocated these revenues according to the percentage of the system comprised by

Port Arthur (57%) versus the three remaining cities, collectively (43%). Thus, the FDRs were

respectively allocated as $102,880 for Port Arthur and $77,612 for the Cities. To account for the

elimination of the prompt payment provision, the Commission deducted $77,612 from TGS’s overall

adjusted revenues, thereby excluding from its calculation the estimated FDRs that would have been

collected in Port Neches, Nederland, and Groves. The Commission, however, maintained in its

revenue calculation the $102,880 of FDR revenues that TGS would collect from Port Arthur

pursuant to the settlement. Because this credit was applied in setting the rates for the three remaining

Cities, which comprise 43% of the system, the amount of Port Arthur FDRs included as a revenue

credit was $44,239 (43% of $102,880).

TGS does not challenge the Commission’s elimination of the prompt payment

provision as an improper penalty relating to the Cities. TGS argues, however, that the Commission

should have eliminated all of the FDRs, including the Port Arthur amounts, from its calculation.

Specifically, as urged by TGS in its motion for rehearing before the Commission, “[t]he proper way

to treat the forfeited discount revenues in this case is to subtract all of them from the ‘other revenues’

and proceed to set base rates on the basis of the new (higher) number,” which would eliminate the

$44,239 “subsidy.” According to TGS, it was error for the Commission to credit the Port Arthur

19
FDRs against TGS’s revenue requirement because those rates were imposed and those revenues

werecollected pursuant to a separate settlement agreement that was not before the Commission on

appeal.

Both the Commission and the Cities respond that the Port Arthur FDRs were properly

included in the rate calculation as a revenue credit because TGS invited that result by filing a rate

request based on a systemwide test year. We do not find merit in this argument. As previously

discussed, the historical test-year data was presented based on systemwide costs and revenues for

an integrated system. This data accounted for the revenues collected from Port Arthur in that test

year. It would double-count such revenues to credit to the Cities an additional amount for the Port

Arthur FDRs that were being paid only by Port Arthur pursuant to a separate settlement agreement.

Stated another way, under the Commission’s order, the Cities’ rates were offset by revenues that

would never be collected from the Cities, but were instead being paid by Port Arthur, which resulted

in a deficiency to TGS of $44,239.

We agree with TGS that this portion of the Commission’s order violates the

Commission’s statutory authority. Just as the Commission properly excluded the increased Port

Arthur settlement revenues in its rate calculation because they were outside the scope of the test year

and would result in under-recovery to TGS,11 the Commission should have excluded the Port Arthur

FDRs from its rate calculation. We have not been cited to any testimony or documentary evidence

in the record, nor has our independent review of the record revealed any such evidence, that was

presented to the Commission in support of crediting the Port Arthur FDRs as an offset against the

11
See discussion infra regarding “Increased Settlement Revenues.”

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revenue requirement. Apparently, no witness testified about how this calculation should be

performed or the legal basis behind it.

Therefore, we conclude that the Commission’s treatment of the Port Arthur FDRs as

a credit against the revenue requirement was not supported by substantial evidence in the record and

was in violation of the Commission’s statutory authority. This portion of the Commission’s order

prejudiced the substantial rights of TGS by causing an under-recovery of its rates. See Tex. Gov’t

Code Ann. § 2001.174. We sustain TGS’s first issue.

Rate Case Expenses

In its second issue, TGS argues that the district court erred by affirming the portion

of the Commission’s order that disallowed TGS recovery of certain rate cases expenses—namely,

those incurred by hiring June Dively of Dively & Associates as a consultant to analyze data and

present testimony about her analysis.

TGS sought recovery of $812,324.47 in rate case expenses, $80,480 of which was for

the fees paid to Dively. Although the Commission approved TGS’s recovery of $665,010.75 in rate

case expenses,12 the Commission found that recovery of the remainder was not reasonable.

Specifically, the Commission determined that TGS could not recover its expenses for Dively because

she “was retained to ascertain the effects of the merger between ONEOK and [Southern Union].”

12
The Commission allocated $530,690.75 of these to “actual work performed” and $134,320
for “estimated future rate case expenses.” These allowable expenses were to be collected as a
surcharge on rates over a 60-month period.

21
TGS argues that the Commission’s refusal to grant TGS recovery of the expenses associated with

Dively’s work was arbitrary, erroneous, and not supported by substantial evidence. We disagree.

The Commission has broad discretion to determine recovery of expenses in a

ratemaking proceeding. City of El Paso v. Public Util. Comm’n, 916 S.W.2d 515, 522 (Tex.

App.—Austin 1995), appeal dism’d by agr., 1996 Tex. App. LEXIS 1010 (Tex. App.—Austin Mar.

13, 1996). GURA section 104.055 addresses this authority and permits the Commission to adopt

rules for “including and excluding certain expenses in computing the rates.” Tex. Util. Code Ann.

§ 104.055(d), (e) (West 1998); see also id. § 104.057 (additional limitations on allowable expenses).

The Commission has adopted such rules in the administrative code. Section 7.5530 provides that

a party seeking to recover rate case expenses in any rate proceeding must prove by a preponderance

of the evidence that the expenses are reasonable. 16 Tex. Admin. Code § 7.5530(a) (2002). This

includes the recovery of expenses for professional services, such as consulting. Id. The Commission

must “consider all relevant factors” in determining whether to allow recovery of the expenses,

including whether the work or testimony was duplicative of others and whether the work was

relevant and reasonably necessary to the proceeding. Id. § 7.5530(b).

Moreover, regarding the evidence presented about the reasonableness and necessity

of a rate case expense, the agency is the sole judge of the weight of the evidence and the credibility

of the witnesses. City of Corpus Christi v. Public Util. Comm’n, 188 S.W.3d 681, 695 (Tex.

App.—Austin 2005, pet. filed). Even still, the Commission may not disregard undisputed facts or

testimony unless the record contains “some explanation or reason upon which the reasonableness

of their action might be judged.” Cities of Port Arthur, Port Neches, Nederland, & Groves v.

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Railroad Comm’n, 886 S.W.2d 266, 271 (Tex. App.—Austin 1994, no writ) (reversing

Commission’s conclusion that Cities could recover expenses for only 263 hours of attorneys’ work

because Commission provided no explanation for disregarding undisputed affidavit that 522.76

hours of work had been performed). This explanation or reason need not appear in the final order,

however; it is sufficient if contained elsewhere in the record, such as in the PFD. Id. at 273 (because

Commission’s finding of fact made apparent that it adopted examiners’ reasoning, explanation set

forth in PFD demonstrated reasonable basis for Commission’s action); see also CenterPoint Energy,

2006 Tex. App. LEXIS 3518, at *19-20 (reversing Commission’s “implicit rejection of []

uncontroverted testimony” because no basis or explanation for action was provided in final order,

PFD, or other evidence); City of Amarillo, 894 S.W.2d at 496 & n.4 (reading final order and PFD

collectively, reasonable basis for Commission’s refusal to allow recovery of rate case expenses for

consultant’s fees was apparent from record).

Here, the Commission disallowed recovery of Dively’s fees, despite the essentially

undisputed13 testimony of J. Kay Trostle, an Austin attorney, who testified on behalf of TGS that the

requested expenses for Dively’s work were reasonable and necessary. She noted, in fact, that Dively

charged only $80 per hour, which Trostle characterized as being a low rate for a utility consultant.

13
Although the Cities presented testimony from Daniel J. Lawton, a consultant with
Diversified Utility Consultants, Inc., about the unreasonableness of TGS’s requested rate case
expenses, his comments do not specifically address why recovery of Dively’s fees should be denied.
Lawton testified only that “TGS appears to have not properly managed its outside lawyers and
consultants in this case, resulting in excessive charges.” Lawton’s complaint was confined to the
number of attorneys hired by TGS, without addressing the reasonableness of the consultants’ fees.

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Dively’s affidavit, with copies of her invoices demonstrating that her fees were $80,480.00, was

attached in support of Trostle’s testimony.

There is, however, a reasonable basis in the record to support the Commission’s

rejection of Trostle’s testimony. In finding that Dively’s fees did not constitute a reasonable rate

case expense, the Commission adopted the reasoning of the hearing examiners as set forth in the

PFD. The examiners stated that “the rate case expenses incurred as a result of the ONEOK

acquisition should not be borne by the ratepayers and are not recoverable under § 7.5530.” See 16

Tex. Admin. Code § 7.5530(a). The examiners’ recommendation was based on their conclusion that

the evidence and testimony in this case indicate that the work that was done by Ms.
Dively was needed primarily as a result of ONEOK’s acquisition of TGS [sic14]. The
testimony indicates that she spent a considerable amount of time ascertaining the
appropriate allocation amounts as a result of the ONEOK acquisition of TGS. The
evidence indicates that Ms. Dively’s work was necessary as a result of the ONEOK
acquisition and not independently required in order to pursue this rate proceeding.
Therefore, the examiners recommend the Commission reduce TGS’s reimbursable
rate case expenses by $80,480.00.

A review of Dively’s testimony, both on direct and rebuttal, confirms the examiners’ statements.

The examiners further explained that “a substantial portion of the rate case expenses

were incurred as a direct result of the confusion from the utility’s [multiple] filings.” The examiners

concluded that, because TGS brought this confusion on itself by changing its method of calculation

14
ONEOK acquired Southern Union; TGS, as a division of ONEOK, then took over the
Southern Union operations in Texas.

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from one filing to the next, it provided “another basis for denying certain rate case expenses as

discussed above.”15

Because the action ultimately taken by the Commission was supported by a thorough

and accurate explanation in the PFD, which was supported by testimony in the record, we conclude

that the Commission’s disallowance of TGS’s recovery for Dively’s fees was supported by

substantial evidence.

Beyond this, however, TGS raises an additional argument meriting our attention.

TGS contends that it is permitted by GURA to recover as an expense a “payment to an affiliate” if

it demonstrates that the payment was reasonable and necessary. See Tex. Util. Code Ann.

§ 104.055(b). TGS considers the costs associated with the acquisition of Southern Union by

ONEOK (TGS’s corporate parent) to be a “payment to an affiliate.” Because Dively’s testimony was

used to establish the reasonableness and necessity of allocating these acquisition costs, TGS claims

that Dively’s work was “statutorily required,” thereby making the costs associated with her work

recoverable.

TGS, however, makes a subtle, yet impermissible leap in this argument. Just because

the ONEOK acquisition costs may qualify as an “expense or cost of service” under section

104.055(b) does not automatically entitle TGS to recover, as a “rate case expense” the fees of a

15
The examiners noted that “even the nomenclature . . . used to describe the different
elements of the revenue calculation changed” in between filings, which required a “cumbersome
analysis,” wherein TGS spent “considerable time adjusting the numbers to compare ‘apples to
apples.’”

25
consultant used to sponsor the reasonableness and necessity of that “expense or cost of service.” See

id. There is a difference between the “expenses,” contemplated by section 104.055, which must be

“caused by utility service” to be included in the rate calculation, and “rate case expenses,” which are

incurred in the administrative process of presenting one’s rate case and are recovered through a

surcharge. See id.; 16 Tex. Admin. Code § 7.5530. It is true that, in order to include the acquisition

costs as an “expense or cost of service” in TGS’s rate calculation, TGS was required to demonstrate

that those costs were reasonable and necessary. But the leap cannot be made from this fact to TGS’s

conclusion that any fee incurred by TGS in presenting its “cost of service” argument is automatically

recoverable as a rate case expense. This is where the Commission’s discretion, as discussed above,

plays an integral role. Pursuant to section 7.5530, the Commission must consider all relevant factors

and determine whether the rate case expense was reasonable and necessary to the proceeding. 16

Tex. Admin. Code § 7.5530.

TGS responds that the Commission’s refusal to allow recovery of Dively’s fees is,

on its face, arbitrary because the Commission adopted an excerpt of Dively’s testimony in its final

order, finding that the costs about which she testified should be included in the rate calculation. We

disagree. Even if the Commission was persuaded by a portion of Dively’s testimony, this does not,

as a matter of law, entitle TGS to recover the cost of her fees. Especially considering that the

Commission awarded TGS $665,010.75 (82%) of its requested rate case expenses, we cannot say

that the Commission’s disallowance of the recovery of Dively’s fees as a rate case expense

prejudiced TGS’s substantial rights. See Tex. Gov’t Code Ann. § 2001.174. Moreover, even if we

26
may have reached a different conclusion, we may not substitute our judgment for that of the

Commission on a matter such as this, which is committed to the Commission’s discretion. See Gulf

States Utils. Co., 947 S.W.2d at 890; City of El Paso, 916 S.W.2d at 522.

We conclude that the Commission acted within its discretion in adopting the

examiner’s reasoning and in finding that the consultant fees were not recoverable because Dively’s

work “was necessary as a result of the ONEOK acquisition and not independently required in order

to pursue this rate proceeding” and because many of TGS’s rate case expenses were unreasonably

incurred due to the confusion TGS created by its multiple, readjusted filings. TGS’s second issue

is overruled.

CONCLUSION

We hold that the district court did not err in affirming the Commission’s order in

regards to the following decisions: (1) the Commission had statutory authority to include as a

“known and measurable change” in the rate calculation the $159,247 in expenses associated with

ONEOK’s/TGS’s acquisition of Southern Union; (2) the increased Port Arthur settlement revenues

were properly excluded from consideration in the rate calculation; and (3) Dively’s consulting fees

incurred by TGS were properly rejected as a recoverable rate case expense. However, the district

court erred in affirming the portion of the Commission’s order that included $44,239 of forfeited

discount revenues as a credit in the rate calculation.

Accordingly, the district court’s judgment is affirmed in all parts except for its

affirmance of the Commission’s treatment of the forfeited discount revenues. That portion of the

27
judgment is reversed and remanded to the district court, with instructions to remand the cause to the

Commission for further proceedings consistent with this opinion.

W. Kenneth Law, Chief Justice

Before Chief Justice Law, Justices Patterson and Pemberton

Affirmed in Part; Reversed and Remanded in Part

Filed: August 4, 2006

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