Goldmann, Freund and Haneman. The opinion of the court was delivered by Haneman, J.A.D.
This is an appeal by Hackensack Water Company (Hackensack) and by rate counsel appointed by the Attorney General in the public interest from a decision and order of the Board of Public Utility Commissioners of the State of New Jersey (the Board), dated August 27, 1958. The two appeals were consolidated by an order of this court, filed November 20, 1958.
On June 28, 1956 Hackensack filed a schedule of increased rates with the Board, to become effective July 30, 1956. The proposed increase was calculated to produce an additional $2,500,000 in gross annual revenues. On January 18, 1957 the Board advised Hackensack that it would negotiate and agree to a schedule of rates designed to increase revenues by $1,000,000 rather than by $2,500,000, provided that, among other conditions, the negotiated rates would remain in effect for at least one year. On January 25, 1957 Hackensack accepted, and the temporary increase in rates was granted. On December 27, 1957 Hackensack petitioned the Board to reopen hearings for the purpose of permitting the schedule of rates filed on June 28, 1956 to go into effect on February 1, 1958. Hearings were thereafter held in February and March of 1958.
By its decision and order the Board found and determined that $46,827,987 was a fair and reasonable rate base and that a 6% return thereon was fair and reasonable. The
Board as well determined that the existing rates were unjust and unreasonable in that they did not afford Hackensack an opportunity to earn a fair return, but that the rates proposed by Hackensack would yield an excessive return. Hackensack was directed to file a new schedule designed to produce an increase in annual revenue of $1,000,050. In computing operating revenue deductions, the Board disallowed certain payments made to Spring Valley Water Works and Supply Company (Spring Valley) in connection with the operation of DeForest reservoir, and income tax adjustments resulting therefrom. (Both of these subjects are hereafter treated in greater detail.)
Hackensack's appeal is based on the following issues: (1) the Board's refusal to allow as an operating expense the full amount of Hackensack's 1957 payment under a contract with a wholly owned subsidiary company, Spring Valley, for benefits derived from DeForest Lake Reservoir (De Forest), a large impounding and river-regulating reservoir in Rockland County, New York; (2) the Board computed the federal income taxes of Hackensack as if the full annual payment to Spring Valley had been included in operating expenses, notwithstanding the disallowance of part of said payment.
Rate counsel's appeal is based on the following issues: (1) the amount of the rate base allowed by the Board; (2) the amount of the allowance by the Board of the annual operating costs of DeForest; (3) the Board's "normalization" of certain federal income tax deferrals resulting from accelerated amortization under the Internal Revenue Code of 1954, section 168; (4) adjustment of the test year's operating expenses to include 1958 wage increases which Hackensack was committed to pay under a union contract.
Hackensack, incorporated in 1869, is the largest private water utility in New Jersey, and presently supplies a population of about 640,000 in 55 municipalities in Hudson and Bergen Counties. Substantially the sole source of water
supply of Hackensack, and the only source of dependable supply is the Hackensack River and its tributaries above New Milford, New Jersey. The waters of the Hackensack River and its tributaries are stored in three reservoirs. DeForest, located in New York, is the largest, with a storage capacity of 5.6 billion gallons. Oradell Reservoir and Woodcliff Lake, in New Jersey, have a capacity of 3,080 million gallons and 889 million gallons, respectively. Through its wholly-owned subsidiary, Spring Valley, a New York corporation, water is supplied to consumers in the fast-growing southern part of Rockland County, New York. At the present time Spring Valley owns DeForest Reservoir, but does not expect to receive any water from this source for at least three or four years.
The testimony heard by the Board clearly demonstrated Hackensack's need for an additional reservoir prior to the construction of DeForest. Several experts testified that the water supply situation was "critical." The "dependable yield" of the Hackensack River and its tributaries, i.e. , the amount of water which could be obtained during a critical period of extreme drought, was insufficient to meet the demands of the area served by Hackensack. One of the main functions of DeForest is to store water which would normally be wasted. The storage capacity of existing reservoirs was inadequate to save enough water during wet periods for use during drought periods; millions of gallons of water were wasted by flowing over the spillways of Oradell and Woodcliff Lake Reservoirs. When full, DeForest, with its impounded 5.6 billion gallons, is some 40% greater than the combined capacity of the two prior existing reservoirs.
Although Hackensack owned considerable land for a reservoir in New Jersey below DeForest Lake at River Vale, the testimony by engineering experts demonstrated that the best site for present construction was in the State of New York where DeForest is now located, and that that
site would provide the largest and most economical supply of additional water.
George H. Buck, president of Hackensack and Spring Valley, and also an engineering expert, testified that there were two persuasive reasons for building at DeForest in New York rather than at River Vale in New Jersey: (1) although Hackensack controlled the bulk of the land for the proposed River Vale reservoir in New Jersey, it controlled no land for a reservoir in New York. Mr. Buck declared that growth and development in Rockland County, New York, was proceeding so fast that if the real estate were not purchased and developed immediately it would be lost forever as a source of water supply for the inhabitants of New York and New Jersey; (2) the reservoir in New Jersey would have been much smaller in capacity and in yield, and if it had been built first it would only have met Hackensack's requirements up to about 1961 or 1962, and then a reservoir would have been necessary in Rockland County, New York. There is no indication that the means by which Hackensack proceeded to have DeForest constructed were not the most practical and economical.
In accordance with New York law, Spring Valley filed a petition with the New York Water Power and Control Commission seeking approval of the project. Hackensack had received advice from their attorneys that the most feasible legal method of constructing DeForest was to have Spring Valley, a New York corporation, undertake the construction, since Hackensack had no right to condemn in New York nor did it have any franchise rights. In its decision approving the project, the New York Commission determined that the dependable yield of DeForest was 20 million gallons a day. It required a minimum flow below the proposed dam of 7.75 million gallons a day, to which flow it added a quantity of water sufficient for the needs of the Village of Nyack of at least 2 million gallons a day, making a total minimum release of 9.75 million gallons a day, with the
proviso that if Nyack in the future took water from the reservoir, this 2 million gallons a day could be eliminated. Ten million gallons a day was forever reserved for the water supply needs of the residents of Rockland County through the facilities of Spring Valley.
In order for Spring Valley to take water from DeForest it must first build filter facilities. The facilities were not installed in 1957 and they will not be built until management decides to do so. The record indicates that this will not be for four or five years. Therefore, for at least that period of time, as much water as is required can be released downstream into New Jersey. The cost of DeForest, as of December 31, 1957, was $7,134,980, financed by Hackensack through the purchase of Spring Valley's securities.
Hackensack and Spring Valley made an agreement to provide for the allocation of the costs of operation of DeForest. The agreement is for a period of 35 years and provides, in general, for the following terms: Hackensack is to pay a minimum of 55.6% and a maximum of 95% of the total operating costs for any year, plus a sum sufficient to provide to Spring Valley a return of 6% per annum, free of any and all taxes based on or measured by income, upon Hackensack's Allocable Percentage of the Depreciated Cost of the Reservoir for such year. The specific charge for any year depends upon the ratio of the amount of water diverted by Spring Valley to the available yield, subject to the percentage of 55.6%. Thus, in 1957, when Spring Valley used no water from DeForest, Hackensack paid 95% of the "costs." The effect of this formula is to charge Spring Valley for a certain portion of the costs, even if it takes no water from DeForest, in ...