Pacific Gas & Elec. Co. v. San Francisco, 265 U.S. 403 (1924)

MR. JUSTICE BRANDEIS, dissenting.

These cases were tried together. Each challenges as confiscatory an ordinance of the city of San Francisco fixing, for a single year, the price to be charged for gas. The rule of Smyth v. Ames, 169 U.S. 466, was applied. The evidence, in condensed form, comes before us in a record of 943 pages. The master’s original and supplemental reports occupy 131 pages. The master and the court found the rates to be compensatory. Three errors are assigned by the company which relate to depreciation. The facts applicable to the several years differ in part, but the same questions are presented in each. It will tend to clarity to discuss these with reference to the facts of No. 34, which involves the rate for the year beginning July 1, 1913.

First. The depreciation charge allowed for that year for the plant as a whole was $348,853. The company does not complain that this allowance is too small, if treated as an allowance for merely physical observed depreciation. Its claim is that an improved process, which had been introduced at the San Francisco works in 1912 resulted in a saving, during the year 1913-14, of $103,530 in oil and labor; that, in 1913, it had become certain that this process would later render obsolete certain parts of the plant (called stations) which were in use throughout that year, and that, for the purpose of meeting this expected loss in capital through later abandonment of stations, the savings effected by the new process should have been charged against the earnings, and credited to a special depreciation reserve. If, as suggested below, the company’s contention is that only one-half of the savings should be credited to this special depreciation reserve, the action of the district court on this ground is obviously free from objection. For in fact there was included in the year’s depreciation charge, for obsolescence of these stations, $64,962, which is more than one-half of the year’s savings. But its claim here is that the whole of the savings of the year 1913-14 should have been so applied, and that therefore the balance thereof, namely, $38,568, should also have been included in this special depreciation charge.{1}

The sum ($348,853) allowed as the depreciation charge for the year 1913-14 was nearly 3 percent of the then reproduction cost new of the whole plant, other than land. The master and the court found as facts that none of the plant was abandoned during that year, that the change in the process of manufacture was not revolutionary, that, in view of the history of the art, such change or improvements, and resulting obsolescence of parts of the plants, should have been foreseen, that in fact there had been accumulated during the four years preceding 1912, as a general reserve for depreciation, the sum of $2,116,433.95, that this reserve had been charged off by the company to surplus in November, 1911, and that, but for this fact, it would have been available to meet the loss of capital which occurred later through the abandonment of stations.

This alleged error does not present any question of law. Whether more of the savings of the year 1913-14 due to the introduction of the new process should have been allowed as a special depreciation charge for the obsolescence then known to be accruing is clearly a question of fact. T here is much conflict in the theories on which depreciation should be figured.{2} There was doubt when the obsolescence would culminate, and what would be its extent. There was conflict in the evidence as to the rate to be deemed a fair return. Whether a return of 7 percent is the proper test of a compensatory rate must obviously depend in part upon whether the return includes any of the risk of obsolescence.{3} I cannot say that the master and the court erred in their conclusion of fact that, all things considered, the depreciation charge allowed was adequate. The same is true of the depreciation charges allowed for the years 1914 and 1915.{4}

Second. As an alternative to allowing a larger depreciation charge out of the year’s savings through the improved process and apparatus, the company urges that the rate base should have been increased by adding thereto the value of the right to use the new process at the San Francisco works.{5} The court apparently adopted this view of the law. It ruled that the company was entitled to a return upon the then value (as part of the rate base) of the right to use the inventions. It differed from the company only in the estimate of the value. The company’s experts declared that the value of this right might be ascertained by capitalizing the average annual savings expected to be effected thereby. So calculated, the value is $4,203,300. The court found specifically that it could not accept estimated savings as a measure of value; among other reasons, because the amount of savings was dependent in large measure upon the price of crude oil, and that this price fluctuates largely from time to time. It included in the rate base for 1913-14 the value of the gas generators (at the Metropolitan plant) which had been reconstructed so as to embody the inventions, and found that there was in the record no evidence on which it could give to the right to use the inventions a greater value than was allowed. So far as concerns the year 1913-14, the question is merely whether, on the evidence in the record, the value of the reconstructed generators (including, of course, the right to use them) was too small.{6} It appeared that, for the right to use the inventions, nothing was paid either during the year 1913-14 or during the year 1914-15, and that, for the exclusive right to use them both in San Francisco and throughout a number of counties in Northern California, the company paid to the inventors, in November, 1915, $46,066.68. I cannot say that the master and the district court erred in the finding of fact by which they valued this item for that year, or in the value assigned to the right in fixing the rate base for either of the two following years.{7} This alternative contention of the company presents, obviously, no question of law.

Third. The reproduction cost new of the manufacturing and distributing plant, other than land, was found to be $12,794,008; the accrued depreciation, $1,518,390 (as of June 30, 1914). Thus, the property was found to be worth 88.1 percent of its then reproduction cost. The company contends that the accrued depreciation should have been set at $828,916.41, so that the plant was worth 93.7 percent of its then reproduction cost. The master employed the "compound interest" or "modified sinking fund" method of estimating accrued depreciation. The plant is in part very old. The depreciation found is but a small percentage of the reproduction cost. The evidence bearing upon the amount to be deducted for accrued depreciation occupies 232 pages of the record. The discussion thereof in the master’s report occupies 39 pages. There was a conflict of evidence.

No question of law is presented by this assignment of error.{8} The company’s objection is not to the particular method selected, but that, in applying it, the master included as depreciation what is called theoretical inadequacy and obsolescence. Whether he did is a question of fact. The city denies that the reduction in value made by the master on account of accrued depreciation includes any sum representing expected loss through future abandonment of the stations. It is clear that, if any deduction was made on account of the probable abandonment of the stations, the obsolescence thus provided for was not theoretical. The new process had been introduced two years before the date as of which the valuation was made. On the facts then known, it was expected that the stations would have to be abandoned in the near future. Because it was to be expected (and was not theoretical), the company contended that to offset it, more of the year’s savings should have been charged against the income of that year. I cannot say that the master and the court erred in their findings of fact as to the amount of accrued depreciation.

This litigation has already extended over 11 years. The record discloses that the cases were presented below by competent counsel with the aid of competent experts, and that they received careful consideration by an able master and an able trial judge. Counsel, master, and court have throughout endeavored to apply the rule of Smyth v. Ames, 169 U.S. 466. It was not shown that the rule has in any respect been departed from. This Court harbors a doubt whether, in applying it, some injustice may not have been done to the company. Is it probable that a nearer approach to justice as between the parties will be attained by a continuation of the effort to apply the same rule? To me it seems that the doubt is inherent in the rule itself. It can be overcome only by substituting some other rule for that found to be unworkable. Such other lies near at hand, and it is consistent with the Constitution.

It was settled by Knoxville v. Knoxville Water Co., 212 U.S. 1, that every public utility must, at its peril, provide an adequate amount to cover depreciation. A depreciation charge resembles a life insurance premium. The depreciation reserve, to which it is credited, supplies insurance for the plant against its inevitable decadence, as the life insurance reserve supplies the fund to meet the agreed value of the lost human life. To determine what the amount of the annual life insurance premium should be is a much simpler task than to determine the proper depreciation charge. For life insurance is a cooperative undertaking. The premium to be fixed is not that required by the probable duration of the life of a single insured individual, but that required by the average expectancy of life of men or women of the given age. Moreover, for human lives, mortality tables have been constructed which embody the results of large experience and long study. By their use, the required premium may be fixed with an approximation to accuracy. But, despite the relative simplicity of the problem, it was found that the variables leave so wide a margin for error that premiums fixed in accordance with mortality tables work serious injustice either to the insurer or to the insured. Although the purpose was to charge only the appropriate premium, the transaction resulted sometimes in bankruptcy of the insurer, sometimes in his securing profits which seemed extortionate, and, rarely in his receiving only the intended fair compensation for the service rendered. Because every attempt to approximate more nearly the amount of required premium proved futile, justice was sought by another route. Ultimately, strictly mutual insurance was adopted. Under it, the premium charged is made clearly ample, and the part thereof which proves not to have been needed inures in some form to the benefit of him who paid it. Compare Penn Mutual Life Insurance Co. v. Lederer, 252 U.S. 523, 524-525.

Legal science can solve the problem of the just depreciation charge for public utilities in a similar manner. Under the rule which fixes the rate base at the amount prudently invested, the inevitable errors incident to fixing the year’s depreciation charge do not result in injustice either to the utility or to the community. If, when plant must be replaced, the amount set aside for depreciation proves to have been inadequate, and investment of new capital is required, the utility is permitted to earn the annual cost of the new capital. If, on the other hand, the amount set aside for depreciation proves to have been excessive, the income from the surplus reserve operates as a credit to reduce the current capital charge which the rates must earn. If a new device is adopted which involves additional investment (to buy a new plant or a patent right), the company’s investment, on which the return must be paid, is increased by that amount. If the new device does not involve new investment, but the innovation involves increased current payments (like royalties for use of a process), the additional disbursement is borne by the community as an operating expense. The cost of a scrapped plant is carried as part of the investment on which a return must be paid unless and until it has been retired, that is fully paid for, out of the depreciation reserve. Thus, justice both to the owners of the utility and to the public is assured.