NY Court of Appeals Says PSC "Lightened Regulation" of New Electric Companies Justifies Local Property Tax Reductions

The New York PSC's "Light Regulation" Regime for New Electric Companies
In the 1990's heyday of electricity deregulation championed by Enron, 15 state legislatures authorized "restructuring" of their electric industries. In contrast to legislative action in other states, the New York PSC engineered the voluntary divestiture of utility power plants to new utilities through a series of agreements and orders. Retail utilities like Con Edison agreed to sell nearly all of their power plants to new companies. As a result, far more electricity must now be purchased in wholesale markets to serve retail customers. Typically these purchases are made at "market-based" wholesale rates under the jurisdiction of the Federal Energy Regulatory Commission (FERC). Residential and industrial customers have protested FERC's market rate regime, in which the benefit of the lower cost electricity from more efficient or depreciated power plants no longer flows to consumers. Today, the benefit of lower cost energy, say, from hydro, nuclear, or coal plants is reaped by wholesale utilities with "market-based" rates who are allowed by FERC to charge rates based on the price demanded by the most expensive plant running at any given time.

The New York PSC's "Realistic Appraisal" of Which Laws to Enforce
In granting certificates to the new electric companies, the PSC purported to waive many statutory requirements. The PSC asserted that it could make a "realistic appraisal" of which of the many laws applicable to electric companies, passed over the last 100 years by the legislature, should now apply to new owners of divested power plants. The PSC issued "light regulation" orders for each of the new companies, and in doing so, an alternative regulatory regime was created by PSC orders. See PULP's summary of PSC restructuring orders.

The "light regulation" orders purport to lift the PSL Section 65 utility obligation to provide safe and adequate retail service at reasonable rates to customers upon the customers' demand. They are premised upon assertions that the new electric companies intended to sell only at wholesale. It is an open question whether in the future, in recognition of the malfunctioning FERC-supervised market rate regime, the PSC could make a new "realistic appraisal" and require the new utilities to make some or all of their output available for the benefit of retail customers at reasonable cost-based rates.

Leveraging PSC "Light Regulation" Orders Into Local Property Tax Reductions
Armed with a "lightened regulation" decision of the PSC, a new electric company that bought a power plant from an older utility, Con Edison, sought to reduce its New York City property taxes. The relevant state law, Section 1801(c) of the New York Real Property Tax Law, establishes categories of taxation, and allows higher taxes upon PSC supervised utilities than upon companies engaged in general commercial activities. This higher taxation of utility property could be due to the heavy impact and burdens placed upon local land use and air quality by polluting power plants.

The definition of "utility" property in the tax law is:

c) "Utility real property" for the purposes of this article means the real property, including special franchises, of persons and corporations subject to the supervision of the state department of public service, the state department of transportation, or any other regulatory agency of the state or federal government, used in the generation, storage, transmission, distribution or sale of gas, electricity, steam, water, refrigeration, cable television, telephone or telegraph service, delivered through mains, pipes, cables, lines or wires, provided, however, that "utility real property" shall not include the types of real property, property or land described in paragraph (a) or (b) of subdivision twelve of section one hundred two of this chapter owned by such persons and corporations.

The section 102(12) (a) and (b) property excepted from the definition is ordinary land and buildings. The "utility real property" tax classification thus turns on whether the company is "subject to the supervision of the state department of public service . . . or any other regulatory agency of the state or federal government."

There can be no doubt that electric companies are under PSC "supervision." Electric companies are broadly defined by the New York Public Service Law 2(13) to include companies owning electric plants, and the PSC is broadly charged by the legislature with the power and duty to oversee all electric companies in PSL section 5:

§ 5. Jurisdiction, powers and duties of public service commission. 1. The jurisdiction, supervision, powers and duties of the public service commission shall extend under this chapter . . . .
b. To the manufacture, conveying, transportation, sale or distribution of gas (natural or manufactured or mixture of both) and electricity for light, heat or power, to gas plants and to electric plants and to the persons or corporations owning, leasing or operating the same.

The PSC "lightened regulation" orders held that all of the new companies that bought power plants from the older utilities are "electric companies" with "electric plants" as defined in Public Service Law 2(12 and (13).

A new utility's attempt to challenge its tax status as a "supervised" utility and thus escape the "utility real property" tax classification would seem to be a "no-brainer" in favor of the taxing authority, and indeed a lower court rejected the effort. But when the issue came to the Appellate Division and then to the state's highest court, New York Court of Appeals, in Matter of Astoria Gas Turbine Power, LLC v. Tax Commission of City of New York, the new electric company (AGTP) was found not to be sufficiently "supervised" by the PSC to warrant its continued taxation in the "utility" classification. Thus, the PSC's restructuring and its decision not to exercise its full powers over the new electric company leveraged a local property tax reduction. As a result, power plants must now be taxed in the same category as general commercial businesses.

While flawed in its analysis, the decision is quite interesting in its misapprehension of the PSC's restructuring. The Court said

"During the past three decades, both Congress and the New York State Legislature have sought to deregulate the electric utility industry."

Actually, while utilities continue to clamor for deregulation, neither Congress nor the New York Legislature actually "deregulated" the electric industry. To be sure, Congress and the New York Legislature at times have sought to induce competition, but the new utilities, including the petitioner in the Court of Appeals case, have not been "deregulated," and they are generally subject to the same laws as the traditional utilities. For example, the core principles of the Federal Power Act and the state Public Service Law that require publicly filed rates subject to review for reasonableness have not been changed. To the extent "deregulation" has occurred, it has been due to FERC or PSC forbearance and decisions not to enforce statutes that remain on the books.

The Court of Appeals sought to distinguish the new electric company owning the power plant sold from the traditional utility, stating:

traditional public utilities are generally afforded certain economic advantages. For instance, public utilities have historically exercised monopoly power, protecting them against competition. In addition, public utilities typically are afforded governmental franchises permitting them to place equipment on public rights-of-way or otherwise use public land. Given public utilities' competitive and financial advantages, the PSC establishes rates at which they can sell their product.

Much of the rationale for FERC and PSC approach to longstanding statutes rests upon the fallacious reductionism reflected in the court decision, i.e., the only reason for regulation is to protect consumers from monopoly providers, so the statutes can be disregarded if multiple providers appear. This, however, is a spurious distinction: nowhere in the Public Service Law does the word "monopoly" occur. The rationale for PSC regulation of electric service and supervision of electric companies is that electric service is a public service and the public interest is affected. It makes no difference whether the service is provided by a monopoly utility or multiple utilities. Actually, when the New York Public Service Law was first enacted, there were hundreds of electric companies and some of them competed in the same localities without local exclusive franchises, which emerged later.

The Court of Appeals' decision posits that the same plant could be taxed higher in the past when owned by a traditional utility only because of the benefits of PSC rate regulation, and that should be changed because the wholesale prices of the plant are no longer supervised by the PSC:

In fixing a public utility's classification for tax purposes, RPTL 1802(1) and 1801(c) take into account that the public utility is virtually guaranteed to earn a reasonable rate of return. In light of the economic advantages afforded to public utilities, New York's tax scheme has treated them differently than other types of entities.

The premise that because the new utilities are "competitive" they cannot pass through their costs, including their taxes, is fallacious. Most wholesale utilities voluntarily choose to sell at market rates under FERC jurisdiction, rather than file cost-based rates or at retail under PSC jurisdiction. When they are found to have market power or manipulate markets, then they file cost-based rates. They are free, however, at any time to file cost based wholesale rates with FERC, or cost-based retail rates with the PSC, and to include their local property taxes as a cost in calculation of the rates when the file or change them. Apparently, they do not choose to file cost-based rates because their opportunities to receive greater revenues are higher with market rates . Also, one would assume that when purchasing the power plant the buyer knew what the taxes were, and had a business plan that would enable it to recover its operating costs and investment and a profit. The tax reduction is simply a windfall, particularly for power plants with low production costs whose market rates are often set by sellers with more expensive power plants.

The court decision says that fully regulated utilities are "virtually guaranteed" to earn a reasonable return. That was never the legal standard: utility rates are set to give only a fair opportunity to earn a reasonable return. There are instances in which regulated utilities fail to earn their allowed returns on capital investment, or in which their investment costs or operating expense claims are disallowed in whole or in part for being excessive, unreasonable or imprudent. When the power plant was owned by a fully regulated utility, the utility was at risk of competitive pressures that could result in "stranding" of utility investment without recovery from ratepayers if, for example, the plant was inefficient and did not run.

The Court rested its decision on a fallacious distinction between the new and old utilities:

Unlike a utility, AGTP is not assured a reasonable rate of return, but is at the mercy of volatile competitive market forces based on supply and demand. Further, AGTP possesses no governmental franchises or property interests in public streets. Thus, in conformance with the Legislature's initiative to deregulate the electric utility industry, AGTP is a competitive entity like those whose real property is properly placed in class four."

Of course, the court offers no citation to any statute reflecting "the Legislature's initiative to deregulate the electric utility industry" because there is no such law. Also, the Court's analysis does not consider the possibility that a new "lightly regulated" company might someday choose to sell at retail, and could file retail rates with the PSC subject to PSC review, or cost-based wholesale rates at FERC. Under those scenarios, the new utility could avail itself of all the perceived advantages of rate regulation.

The tax statute quoted above plainly provides for utility tax treatment if the company is subject to supervision by the PSC "or any other regulatory agency of the state or federal government. The utility in the case was under FERC rate supervision. According to a siting board decision," AGTP is wholly-owned by NRG Northeast Generating, LLC, which is held 50% by Northeast Generation Holding, LLC and 50% by NRG Eastern, LLC; the latter two companies are whollyowned by NRG." NRG Energy, Inc. is a utility subject to FERC regulation, as NRG acknowledges in its SEC Annual Report for 2005:

Federal Power Act. The FPA gives FERC exclusive rate-making jurisdiction over wholesale sales of electricity and transmission of electricity in interstate commerce. Under the FPA, FERC, with certain exceptions, regulates the owners of facilities used for the wholesale sale of electricity or transmission in interstate commerce as public utilities. The FPA also gives FERC jurisdiction to review certain transactions and numerous other activities of public utilities. . . . Public utilities under the FPA are required to obtain FERC’s acceptance, pursuant to Section 205 of the FPA, of their rate schedules for wholesale sales of electricity. All of NRG’s non-QF generating companies and power marketing affiliates in the United States make sales of electricity pursuant to market-based rates authorized by FERC. FERC’s orders that grant NRG’s generating and power marketing companies market-based rate authority reserve the right to revoke or revise that authority. . . . If NRG’s generating and power marketing companies were to lose their market-based rate authority, such companies would be required to obtain FERC’s acceptance of a cost-of-service rate schedule and would become subject to the accounting, record-keeping and reporting requirements that are imposed on utilities with cost-based rate schedules.

The court decision does not address the fact that wholesale sellers of electricity are subject to the supervision of FERC and that NRG could, if it chose to do so, or if required by FERC as a result of market rate revocation, file cost based rates that include local taxes as part of the cost of service, just as Con Edison could have done when rates for electricity from the plant were under PSC jurisdiction.

The decision only partially quotes the relevant statute and completely omits the portion of the statute which defines "utility" property as being subject to supervision of the PSC " or any other regulatory agency of the state or federal government." As a result there is no mention of the fact that the seller is still subject to full FERC supervision of its rates. That FERC has allowed companies, at their option, to seek market rates in no way diminishes the ability of the utilities to set cost based rates that will cover their expenses, including local property taxes.

In sum, this seriously flawed decision represents a victory for the new "lightly regulated" electric companies and a defeat for local taxing authorities. As a result, localities that accepted power plants and taxed them as utility property will not be able to impose taxes higher than if they were a supermarket or other commercial establishment having less environmental impact. The victory could be temporary, however, if the tax law definitions of "utility real property" and regulatory "supervision" are redefined by the New York legislature to close the loophole carved out in the AGTP case.

Recognition of Continued PSC Regulation Regarding Safety, Reliability, Infrastructure Improvement and Market Power
In an interesting turn, despite its finding that the new utilities are not "supervised" by the PSC, the Court recognized that

the PSC maintains "light regulation" over AGTP covering "matters such as enforcement, investigation, safety, reliability and system improvement . . . . This light regulation also gives the PSC authority to limit AGTP's power in the market and any actions in contravention of the public interest.

Although labeled "light regulation," these are very major matters affecting the public interest that remain subject to PSC "supervision." Over time, the decision may be overruled by the legislature to restore utility tax classifications, and its broader implications may be seen as judicial recognition that despite claims of "deregulation," the new wholesale electric companies remain subject to PSC regulation regarding matters other than their FERC-supervised rates. This is significant because the new electric companies have contended they are free to withhold their power from the market or shut down completely, for economic reasons which may include perpetuation of shortages and maintaining higher prices for other plants in their fleets.

The recognition that the PSC has oversight over market power of the new utilities is especially significant. When the old utilities divested their power plant fleets, the plants were sold to a relatively small number of companies which may be able to exert market power and maintain unreasonably high prices. As more is learned about the operation of the NYISO spot markets, and if, as is widely expected, the wholesale power generation sector consolidates further through mergers in the coming years, the Court of Appeals' recognition the New York PSC has power to review market power may become more important than the property tax break it upheld. For example, the decision could support PSC review of behavior of sellers in NYISO markets, disapproval of mergers, or conditioning mergers upon a requirement that electric companies sell only at cost-based rates.

Updates
Chuck Bennett, Shocking and Tricky Power Play: Firms Call Selves Factories to Finagle Tax Break, N.Y. Post, April 6, 2011

Hannah Northey, New York City and FERC Square Off, E&E Reporter, April 4, 2011

David Seifman and Bill Sanderson, Mike to rate-$lapped NYers: Turn down A/C, N.Y. Post, April 2, 2011

William Pentland, New York City's Electricity Prices May Double by 2014, Forbes, April 4, 2011

Devlin Barrett, Electricity Reversal Sought, Wall Street Journal, April 2, 2011 ("the expected hike in power bills . . . was first reported in the New York Post").

Bill Sanderson, New York Electric Bills to Soar 12%, N.Y. Post, April 1, 2011.

NYISO Compliance Filing, March 29, 2011, ("The NYC Demand Curve included in the compliance filing reflects the addition of property taxes. Consistent with the findings reported in the NYISO Demand Curve Report,12 inclusion of property taxes results in a 41% increase in the NYC Demand Curve.)"

FERC Order Accepting Tariff Revisions Subject To Modification, Suspending For Five Months, And Directing Compliance Filing, Jan. 28, 2011("Property taxes are legitimate costs that are normally included the cost of new entry; NYISO has not shown that they will not be incurred by
peaking units that will be constructed in New York City....Accordingly, because of the questionable eligibility of a peaking unit and the fact that such abatement is discretionary, we direct NYISO to exclude tax abatement from the calculation of net CONE for NYC").