X\M Rates for G^s Service Ey <-«L. Cory --'> -y 6 V V ^^J^ U \ \- . i --/iii .^■ m- ■V "V^-^ RATES FOR GAS SERVICE 3yC. L CORY "PAPER READ BEFORE "PACIFIC COAST GAS ASSO- CIATION. OAKLAND, CALIF.. SEPT. 19. 20. 2 1 . f 91 1 Reprint JOURNAL OF ELECTRICITY, 'POWER AND CAS 1^ ^0 RATES FOR GAS SERVICE. BY C. L. CORY. In all probability more money has been expended in the various States and cities of the Pacific Coast during the past decade, either directly or indirectly, ^ =^ in connection with litigation or other phases in deter- mining the rates for gas service, than has been the cost, in the same territory, of all experimental and other related scientific and enQ;ineerin2: work of im- proving the methods and reducing the cost of the manufacture, distribution and sale of gas. Certainly, there is no problem connected with the gas industries more important than that of rates. There is a spend- ing and receiving side to every organization. It is the difiference between what is spent to provide a com- modity and the amount for which the commodity in the aggregate is sold which establishes the desira- bility of the business. Unlimited commendation is due the gas engineers of the Pacific Coast for the work they have done in recent years to improve the pro- cesses of gas manufacture, including all of the notable advances in high pressure distribution and improve- ment of service, as well as the increased economies and reduced cost of production. It is but natural, therefore, that we should be equally interested in the consumption and use and especially the proper rates to be charged for gas, not only from the stand- point of the manufacturing companies, but quite as much must the consumer's position in the matter be given due consideration. *The term "public utility" has been defined as meaning and embracing each corporation, company, firm, individual and association, such as express, telephone, telegraph, sleeping car, freight-line, equip- ment, electric light, gas, natural gas, pipe line, water- works, messenger, signal, union depot, water trans- *L,a\vs of Ohio, Langdon Act. 1910, Page 429. L'28254 Rates for Gas Service portation, heating and cooling companies ; street, steam, suburban and interurban railroad companies ; also any plant or property owned or operated by such companies, corporations, firms, individuals or associations. It is such companies as above indicated that pro- vide service to the public, and the rates for such serv- ice should be based primarily upon the cost of pro- viding adequate and satisfactory service. To deter- mine this cost is many times a difficult task, and espe- cially So when the devices and system required to pro- vide the service are not fully developed and standard- ized. As an illustration, the rates for freight and pas- senger service between San Francisco and Los An- geles, whether by steamer or by rail, have been estab- lished for such a length of time that it is not a diffi- cult matter to decide upon the reasonableness of such rates, and, therefore, rates may be established that are more or less permanent and not subject to material revision from year to year. However, to determine adequate freight and passenger rates between these cities using the automobile or the aeroplane would be exceedingly difficult, if not impossible. However, it is not to be concluded that in future years, service, both passenger and freight, with the newest aerial devices for transportation may not become so well established, reliable and satisfactory that rates of service might not be readily determined. The business of manufacturing and supplying gas hdS been very thoroughly standardized, although pro- gress is constantly being made in the methods of man- ufacture as well as the increased economies in distri- bution. High pressure systems have been introduced in recent years. The methods of gas manufacture from California crude oil on the Pacific Coast have been per- fected within a comparatively recent date. As com- pared with many other public utility enterprises, how- ever, the gas business has been established so long that the determination of the cost of service is com- paratively easy. The cost of delivering gas to the consumer neces- sarily embraces the determination among other things Rates for Gas Service of a fair valuation of the plant that is devoted to public use, the gross earnings under any given set of rates and the reasonable operating expenses when depreciation of the physical property and adequate re- turns on the investment are included. The general information necessary in order to arrive at the proper rate for gas service may, in gen- eral, be subdivided as follows: 1st. The valuation or appraisal of the plant used for the manufacture and distribution of gas. 2d. The annual cost of operation, including a complete segregation of all accounts set forth in such a manner as to indicate the different operating costs per 1000 cubic feet of gas manufactured and sold. 3d. A statement of the quantity of gas made and sold for a number of years, preferably not less than five, and the total revenues received each year from the sale of gas. Valuation. There are a number of fundamental principles in- volved in obtaining the valuation of a gas plant and system to be used in determining a proper rate for gas service. It is quite as important that corporations themselves should determine for each year the valua- tion of the system upon which a return on the invest- ment is to be earned as it is for this valuation to be determined by any public body, whether only inci- dentally or directly concerned, with the fixing of rates. The original cost of construction, the cost of re- construction or reproduction new, the cost of repro- duction new less depreciation, the present value, the assets and liabilities taken as a whole, the capitaliza- tion, the bonds and stock outstanding, and the gross earnings and operating expenses are all elements that should be considered in determining the valuation of a public utility for rate fixing or other purposes. Each of these elements constitutes evidence of wdiat is a fair value. The original cost, the cost of reproduc- tion new and the present value bear a very close re- lation to the physical property of the plant and are, therefore, most usually considered of the greatest im- Rates for Gas Service portance in determining the proper valuation. Which of these three elements gives the best indication of the value will vary in each individual case. The original cost can, if all records of construc- tion are available, be usually determined by what is known as the historical method. The conditions under which the construction of the system was car- ried out, whether all done at once or extended from year to year as the growth of the business required, will be covered in this method of determining the or- iginal cost. When proper charges only are included and no mistakes: have been made, for which the build- ers may be properly held responsible, the original cost represents the investment that has actually been made in the physical property of the plant. The rapid growth of many systems, however, and the rapidity with which changes have been made, coupled with inadequate records, make it many times practically impossible to determine the original cost with any degree of reliability. Much depends upon the manner in which accounts and records have been kept. In order to be of value they should show the actual cost of the different parts of the plant, segregating labor and material, the cost of engineer- ing superintendence, management, and administration, the amount that has been allowed as interest on the capital during the construction period, the cost of financing, which will include the discount at which bonds were sold, the basis upon which stock has been issued or sold, all promotion expenses and similar items. It is not difficult to imagine records which would give the above information, but I venture to say that most rare is it that the original cost of a gas plant operating at the present time may be ob- tained entirely in such a complete and satisfactory manner. Moreover, the original cost even when determined in full detail may not be the valuation upon which rea- sonable returns should be allowed. It is a question of equity between owners of the plant on one hand and the customers on the other. The owners are en- titled to a reasonable return upon what they have in- Rates for Gas Service vested, while the customers should not pay rates for service that will yield more than an adequate return upon the investment necessary to supply such service. If the plant has been built when prices were abnor- mally high and money has been lost through lack of reasonable skill, excessive promotion fees and dis- counts, private understandings between the builders of the plant and the contractors, the original cost may be decidedly greater than the valuation on which the investors should be allowed to earn. Conversely, it may be that the plant was con- structed when the prices for labor and material were excessively low, or a great portion of the plant may have been obtained through failure of previous owners to successfully carry on the business, due either to temporary financial difficulties or what has been more common, great strides in the method of manufacture, resulting ultimately in foreclosure. In such a case the original cost would hardly be a fair figure upon which to base the valuation for rate fixing purposes, as the foresight and enterprise of the present owners certainly justifies some regard. The original cost is so rarely available that the cost of reproduction new of the plant usually must be determined. A great deal of engineering knowledge and detail work is necessary to obtain this result. In- variably, a complete inventory of the physical property is the first step required. The only satisfactory in- ventory is one obtained as a result of actual inspection and enumeration, aided, as much as possible, by all the records available, and supplemented by such addi- tional information as may be had from the various heads of departments and other employees of the com- pany. Such an inventory should include for each dif- ferent part of the property the amount of labor and material required to provide ready for operation each element of the completed plant. The next step con- sists in obtaining from all data obtainable a suitable price per unit, not only of each element of the prop- erty, but the labor and material required to install the devices in position ready for operation. It is well in determining such unit prices to take a period cov- 10 Rates for Gas Service ering at least five years and obtain the average in this manner. The total and average cost of the labor and material that has entered into the plant ready for op- eration is thus obtained. Inventories. Inventories of the actual physical property which taken together go to make up a modern gas plant and system should include the following: Real estate. Furniture and fixtures. Buildings. Automobiles, motorcycles, etc. Gas works, including holders. Stable equipment. Street mains. Tools. Services. Supplies. Meters, regulators and lamps. Working capital. Real Estate. A complete list of all real estate used wholly or in part for the purpose of the manufacture and the supplying of gas should be included in the inven- tory. The values placed upon this real estate should be determined in so far as possible by actual sales of property in the vicinity of the real estate in ques- tion when used for a similar purpose. The purpose for which the property is used must always be taken into consideration. Disinterested real estate men are usually able to give information leading to a rational decision in such matters. Unfortunately, assessments for taxation purposes are not of material assistance in appraising such real estate. On the other hand the actual figures at which adjacent property is sold are rarely available. When a gas company has real estate not actually in use but is holding it for future occupancy the ques- tion naturally arises should such real estate be in- cluded in arriving at the valuation of the plant for the purpose of determining the proper rate for the sale of gas at any given time. In arriving at a conclusion in this matter, it is best to proceed upon the principle that it is proper to include all property actually required and used in the carrying on of the business at the time in question and not to include such real estLte not required or used on the date the valuation is made. However, at some later period when the real estate is actually put Rates for Gas Service il to use and occupied by buildings and equipment, that are a part of the operating system, in arriving at the valuation, there should be added interest and taxes during such time as the investment in such lands has been tied up but not productive. On any other prin- ciple, customers of today would pay a rate for serv- ice in excess of what they should and customers of the future may pay relatively less and thereby benefit unduly. Buildings. All of the buildings owned by the compan}'^ as a part of its operating system should be included in the inventory and so segregated that it will be possible to separate the structures such as office buildings, etc., from the structures required as a part of the manu- facturing plant. This should be done in order to obtain the cost of the manufacture of gas as delivered to the holders separate from the general expenses con- nected with the operating of the property usually con- nected with the expense of the general offices of the company. The inventory costs of all buildings are usually best obtained from the plans, specifications and contracts or other records of the company. The con- dition of the buildings in general usefulness and prob- able future life should be taken into consideration in determining the probable value based upon original cost, cost of reproduction new and present value. Gas Works. The gas works inventory must include besides buildings all of the equipment necessary in the manu- facture, metering and storing of gas, such as boilers, blowers, compressors, generators, exhausters, holders, heaters, pumps, piping, purifiers, scrubbers, and mis- cellaneous equipment. The date of purchase or con- tract and the date when installation was commenced and completed as well as the type of apparatus and by whom manufactured, should be included as a part of the inventory. When possible, the cost of each ele- ment of the entire manufacturing plant ready for oper- ation segregating labor and material is desirable. 12 Rates for Gas Service Street Mains. An inventory of street mains is best obtained by tabulating and mapping from work reports all installa- tions and removals for as long a period as records are available. Scaling street mams from maps in order to obtain the aggregate length of the various sizes should only be resorted to when the actual records of installation are not available. The size of all street mains including fittings and accessories of every char- acter and classified as to the material used, such as wrought iron, cast iron or casing, should be included in the inventory. In a similar manner the cost of re- placing the street surface in the various kinds of pav- ing should be determined from the most recent records available for such work. The item of paving in determining the value of underground street mains and services has been vari- ously considered. Every legitimate expenditure in adapting the utility to the progress and coiiimunity growth, even if this involves the removal of the plant from one locality of the city to a distant and more remote location, is a proper charge to construction. All expenditures for putting down pavement by the company as required by the city or the cost of cutting through such pavement for extensions and construc- tion purposes, and its replacement, are unquestionably proper capital charges. However, it is a question whether a gas company may properly capitalize the expense of municipal betterment which it has not borne and when such benefits to the gas company are only incidental and can only exist from the standpoint of the cost of actually reproducing their underground system, after the street has been paved, when as a matter of fact the existing underground mains and services were laid before the paving was actually put down. The cost of such paving is not a proper ele- ment of value when the cost of laying such pavement has not been paid for by the gas company nor any expense incurred therewith, providing of course that all costs borne by the company of changmg the grade or depth of underground mains and services, in order Rates for Gas Service 13 to adapt them to conditions required for paving by the city, are included in the capital account. Services. In obtaining the inventory of services, it is most satisfactory to list all services, obtaining thereby the size, length, and character of each service as shown by the records of this department. Only that portion of the service belonging to the company should be included and if consumers have paid for any portion of the service that portion should be considered as be- longing to the company. The total value of the ser- vices should represent only those actually owned by the company and in general should not include any services or reproduction of any services within cus- tomers' premises unless the cost of the same has ac- tually been met by the company. In order to arrive at a unit cost of services, it is best to obtain the actual labor and material charge for a number of services installed in various parts of the district served and at different seasons of the year, to get a reliable average cost per unit length of service. Meters, Regulators, Etc. The inventory of meters in service is usually readily obtained from the company's records. The inventory cost of the meters should include the nec- essary testing, painting and all storeroom expense. The cost of installing the meters should include all costs from the time the order leaves the general office until the order and record of installation are returned to the general office. The time cards of meter installers covering a considerable period can with great advantage be used to determine the cost of installing meters of different sizes. Furniture and Fixtures, Automobiles and Motorcycles, Stable Equipment, Tools and Supplies. Complete inventories should be made of the property owned and in actual use by the company for the carrying on of the business covering all subsidiary items such as furniture and fixtures, automobiles and motorcycles, stable equipment, tools and supplies. 14 Rates for Gas Service Only those supplies should be included which are active and of the normal quantity carried in stock and necessary for the operation of the company's business. Working Capital. A gas plant and system in operation must have working capital as well as fixed capital. Stores and supplies which are included in the fixed capital do not represent all of the working capital such plants require. There must be available a reasonable cash balance and other current allowances in order to oper- ate economically and efifectively. Just what sum rep- resents a fair amount for working capital is nearly always a matter of judgment. From the amount of working capital usually carried by such companies and from the amount that is required by other similar public utility corporations, it appears that as an av- erage for the year a sum equalling the accounts re- ceivable and cash on hand less the accounts payable and consumers advance payments is a reasonable allowance. The cash on hand, however, shoul'd be con- sidered as that which is ordinarily required for the operation of the plant and the conduct of the business, including contingencies and emergencies, and should not include the capital or ready cash necessary for the construction of extensions or enlargement of the plant, or balances resulting from the sale of bonds or stock or in any case exceed the amount normally needed and used by the company as an operating property. Such an inventory coupled with what might be called the inventory costs serves to obtain the de- tailed and segregated costs of the various elements going to make up the physical property of the plant. In addition in order to estimate the total valuation it is necessary to ascertain as nearly as may be the time required for construction in order that interest upon the investment during the construction period may be estimated. The cost of engineering, supervision, fire and casualty insurance, administration, legal expenses and other factors must also be obtained, preferably irom the actual working conditions during which re- cent construction work was carried out. Rates for Gas Service 15 Taken together the cost of reproduction new of the physical plant is usually considered to be the sum of the elements above enumert^ted. The cost of repro- duction new has been variously interpreted, sometimes erroneously, especially when it has been held to mean a ' ystem identical with the one the valuation of which is under consideration. Properly, it should be under- stood as a plant of similar character and equal effi- ciency. The age of the system will have much to do in indicating the fairness with which the cost of re- production new is considered. It will depend upon conditions as to whether the cost of production new and the original cost very materially. One of the principal dififerences which will be found will be in the size and capacity and num- ber of units in the two cases. Gas plants are probably never built in a single year, nor used exactly as they were originally constructed for a number of years. The original cost will probably properly rover the plants as installed with small units, while the cost of reproduction new may be considered to cover only the cost of a smaller number of much larger units having the same aggregate capacity. Especially would this difference arise in connection with the distribution system, both mains and services. Originally one sin- gle main on one side of the street of comparatively small size may have been adequate to provide gas serv- ice in that particular vicinity. Later on it became necessary to lay an additional gas main many times larger than the original and as is often the case this later main is laid upon the opposite side of the street, resulting in the cutting of all services leading to prop- erty on the side of the street where the new main is laid and the connection of those services into the new main, instead of the old. As viewed from present re- quirements, one gas main alone might be considered in obtaining the cost of reproduction new, while the actual cost would necessarily be greater. Depreciation in Its Relation to Valuation. While the original cost as well as the cost of re- production new are ordinarily of the greatest import- 16 Rates for Gas Service ance in determining the proper valuation upon which earnings should be based, there is what is often called the present or existing value, or cost of reproduction- new less depreciation, which must be given consid- eration in determining the valuation in question. Especially is this the case in plants the rates for gas service from which have been ample to cover operating expenses, including depreciation, and a fair amount for interest and profits, but the amount collected for depreciation has not been used as it should be and set aside for replacing portions of the plant discarded because of their becoming obsolete, inadequate or worn out, but on the contrary has been distributed to the stockholders in the shape of dividends. Depreciation should be considered as the amount that must be regularly set aside to cover all portions of the plant that are discarded because of wear and tear, inadequacy, obsolescence and general unavoid- able decay. It is an operating expense and should be borne by the customers through the rate paid by them for the service rendered by the utility. But as it is paid by the customers it must be set aside by the company and used when needed for the renewal of worn out and useless portions of the entire system, and under no circumstances should the cost of such re- newals be made an additional charge to the capital or construction account except when the replac--•■■.;, '■*■'■■ iAiMti^»i'Aim vr ■^^S| :^3 :'^f:i ,J'^' ■,yjK>-' jfc%.,. . ^ijg^^ U: Wi ^■:J ':V i ":. I %.. '^:%—-4'^-r K:^-'^' 3%k -t^^ -> ----^ ./ ^ fi>v ; a1& .7 •A;'-^, P- . -- « ■•• .' W'^ •M' 'r -,'■ ^--::^- ,^>»_,...,. v^--: