Thirtieth of a Series of Articles on the Subject—Some Cases of Value Based on Decisions in the Federal Courts

(Continued from last issue)


Capacity of the System

On the peninsula south of San Francisco the Spring Valley system included four storage reservoirs, Lake Merced at the city limits, and the Pilarcitos, San Andreas and Cyrstal Springs at distances up to more than thirty miles.

Table 10: Value of Unused Land and Water Rights of San Francisco Waterworks as of 1904, as Found by the Court in 1911.

Elevations and individual capacities of these reservoirs appear in Table 11, and their combined storage was $28,000,000,000 gallons, representing a supply of 848 days at 33,000,000 gallons per day, if the entire capacity could be drawn out. Besides the above, the Spring Valley system included 1,000 acres of gravel beds near Sunol, on Alameda Creek, across the Bay, and from these beds by means of an underground dam and tunnels some 15,000,000 gallons of water was piped to San Francisco daily.

General View Looking West of Dunbarton Pipe Bridge, San Francisco, to Carry Calveras Water and Eventually Hetch Hetchy.

Table 11: Capacities of the Spring Valley Storage Reservoirs.

By an increase in the height of the Crystal Springs dam and by the construction of dams at Calaveras and other sites on its properties, the company claimed that the total storage could be increased to 100,000,000,000 gallons, and the average daily delivery to 100,000,000 gallons.

Reasoning of the Court

In explanation and justification of his finding of $25,771,984 for the value of Spring Valley water works, Judge Farrington mentioned sundry facts, made comparisons, and quoted a number of Supreme Court opinions.

As to the life of plant and its consequent depreciation, it was pointed out that, in 1899, more than three miles of small pipes were replaced with larger ones. In 1898, five miles of the San Andreas 30-inch pipe line, which had been in use about thirty years, was replaced with 44-inch pipe. The flume from Pilarcitos stone dam to tunnel No. 1 of the Locks Creek line was rebuilt after 33 years’ use. Market Street reservoir and the pipe thereto from Lake Honda had been out of use for a decade. The first pump at Lake Merced, built in 1877, had been broken up and sold for old iron. Upper Crystal Springs dam, completed in 1878 at a cost of more than $219,000, and capable of holding 3,000,000,000 gallons of water, had been practically submerged in the new Crystal Springs reservoir of 19,000,000,000 gallons capacity. The more than 2,000,000 gallons of water furnished daily by Lobos Creek had been contaminated, and so the City Water Works that supplied this water had gone out of use. In toto, structures that had cost nearly $3,500,000, per Table 9, had either disappeared or were no longer used.

Judge Farrington allowed 1 per cent depreciation on cast-iron pipe, 2 per cent on wrought-iron pipe, 2.5 per cent on pumping engines, flumes and wooden structures, and 5 per cent on boilers, yearly, and it was at these percentages that he computed the total general depreciation of $2,922,538, and the annual depreciation of $212,983. For the upper Crystal Springs dam that had cost originally $219,476.61, but was submerged, the judge allowed a value of $50,000, for the upper Pilarcitos dam, also submerged, that had cost about $30,000 he allowed $10,000, and for the Ocean View Pump that originally cost $23,030.58, he allowed $10,000. As to depreciation in general Judge Farrington said in his opinion of October 21, 1911:

“Depreciation may be delayed, but it cannot be prevented. Ultimately every structure in complainant’s plant will be worn out by use wasted by action of the elements, broken by accident, abandoned in the development of the system or displaced by newer and more efficient contrivances. In view of this fact, it was held in the 1908 case that complainant was entitled to an annual allowance to cover such loss. The highest courts have repeatedly declared this fact cannot be ignored in determining the value of property in rate cases. * * *

“The efficiency of the plant undoubtedly has been maintained by repairs and replacements, but to find the property has not depreciated is simply impossible.” Spring Valley Waterworks v. San Francisco, 192 Federal 137, 184, 185.

Concerning the method of valuation by comparison with a substitute system the judge reasoned thus at page 152, quoting Judge Gilbert:

“To say the value of the Spring Valley land and water rights for ratefixing purposes is to be measured by the cost of the Tuolumne system is to say that the price of Spring Valley water should be fixed by comparison with the cost of bringing water from Hetch Hetchy. The same method was applied to railroad charges when rates were based on the cost of hauling freight by mule teams, that mode cf transportation being the next most available substitute. The owner of private property sets the price at which others may buy or use it; he cannot be compelled to accept less; this is his right of contract; but when he devotes his property to public use, he must submit to the right of the public to regulate his compensation for such use, down to what is just both to hims If and to the public, and that compensation is to be based not on the cost of the next available substitute, but on a fair, reasonable value of the property at the time it is used for public convenience. While the cost of a substitute system may be considered in finding the reasonable value of the Spring Valiey plant, it cannot be a controlling element. Otherwise, by securing control of all available sources from which water can be brought to San Francisco the company might force a greatly exaggerated value upon its plant for ratefixing purposes and thus absolutely defeat the very object of government regulation.” Spring Valley Water Co. v. San Francisco, 165 Federal 667.

In 1863, the Spring Valley Company bought from George H Ensign and others a franchise to supply water in San Francisco, and paid for same with stock of the company to the amount of $182,000 at par. In 1865, the Spring Valley Company took over the plant, franchise and going business of the San Francisco City Waterworks, and paid for same $2,200,000 in stock of the purchasing company at par value. In this latter purchase, $2,410,000 was claimed to represent the value of the franchise and going business. On the basis of these transactions, the Spring Valley Company, in the instant case, claimed to be entitled to a return on a franchise value of $2,592,000, under the ruling of the United States Supreme Court in the Wilcox Gas Case. In that case it appeared that seven New York gas companies were authorized by a state statute to consolidate, in 1884, and to issue capital stock for the value of their franchises. Capital stock to the amount of $7,781,000 was issued by the new company on account of these franchises.

(Continued on page 1458)

(Continued from page 1446)

In 1906, when the 80-cent gas law of New York was being contested in the Federal courts, the special master and the lower court found a value of $20,000,000 for the combined franchise and “good will” of the company, hut on appeal the Supreme Court rejected entirely “good will” as an element of value in the rate base and reduced the franchise value to the $7,781,000 at which it was capitalized in 1884. Mr. Justice Peckham wrote the opinion of the Court in the Wilcox case and said as to the franchise value therein, Jan. 12, 1909:

“What has been said herein regarding the value of the franchises in this case has been necessarily founded upon its own peculiar facts, and the decision thereon can form no precedent in regard to the valuation of franchises generally, where the facts are not similar to those in the case before us. We simply accept the sum named as the value under the circumstances stated.” Wilcox v. Consolidated Gas Co., 212 United States 19, 48.

Judge Farrington, after reviewing above Wilcox case, continued thus as to the Spring Valley franchises:

“The case before us presents few features which are similar to those in the Gas Case. According to complainant, there is no history of enormous dividends. There is a story of inadequate returns from the very beginning. * * *

“At the time they became the property of the Spring Valley Waterworks, these franchises were undoubtedly expected to he in force for years, Because of this fact, in 1863 and 1865 they were probably worth the full amount for which they were capitalized; hut the people who took the stock and dealt in these franchises, and the company itself, knew the law, and knew that one would expire in 20 years, that is, in 1878, and the other at the end of 30 years, that is. in 1888. * * *

“It is impossible for the court at this time to find an independent valuation for these franchises, one of which was based upon an unconstitutional statute, and both of which expired years ago. There is no testimony in the case on which any independent franchise valuation can be based.” Spring Valley Water Works v. San Francisco, supra, 169, 170.

The judge said that he valued the water works structure as in use, but refused to add a separate value for the going business, as no evidence had been produced on which such business value could be based. As to testimony that value of the going business should be measured by the deficiency in revenue prior to 1880, on what is known as the Wisconsin Method, the judge quoted the opinion in the Spring Valley rate case of 1904, thus:

“Furthermore, if it be conceded that early deficiency of revenue is the proper measure of value for the present going business, then it follows that the greater the deficiency and the more unprofitable the business, the greater the present value of the going concern: and, if the business had yielded large profits from its very inception, the going business to-day would be worthless.” Spring Valley Water Co. v. San Francisco, 165 Federal 657, 697.

For comparison with his value of $25,771,984, Judge Farrington cited the following figures as the investment in the water works property:

By this comparison it appears that at the prices used by Judge Farrington, as of 1904, all tangible property ever owned by the Spring Valley Company cost $36,158,359, which is $7,997,135 or 28 per cent more than the total investment of $28,161,224. This shows that the average prices used by the judge were substantially above the average original prices at which the company acquired the property. After the deduction of $2,100,199 for sold and abandoned plant, also $3,185,044.95 for depreciation of plant still owned bv the company, a total depreciation of $5,285,243 during the 46 years from 1858 to 1904. the value of tangible property owned by the company was still $30,873,116, in the latter year, or $2,711,891 more than the total investment including that from earnings.

Due to the finding that owned property to the value of $5,101,132 was not used for water supply, the rate base was reduced to $25,771,984, but this sum is greater by $1,601,988 than the total investment of $24,169,996, from stockholders and creditors.

On his value of $25,771,984 for property in use, Judge Farrington found that the ordinance rates prescribed for the Spring Valley Water Company would not yield a fair return and were therefore confiscatory and void, as shown in detail in the sections on “Water Rates and Returns.”

This value of $25,771,984, found by Judge Farrington, in 1911, on a detail inventory and prices as of 1903-1904, may be compared with the tentative value of $26,752,500 which Judge Morrow based on the market value of the outstanding capital stock and bonded and floating debt, as of 1903, and which Judge Gilbert adopted in 190′.

On the 412.74 miles of distribution mains in San Francisco, in 1904, the value of $25,771,984 amounts to $62,441 per mile, and on the 72,632 water service pipes used in that year this value amounts to $354 per service.

In 1900 San Francisco had 342,782 population, and in 1910 it had 416,912, showing an average increase of 7,413 yearly, so that the approximate population was 372.434, in 1904. On this population of 1904 the value of $25,771,984 for the water works property amounts to $69.19 per capita.




Twenty-Ninth of a Series of Articles on the Subject—Some Cases of Value Based on Decisions in the Federal Courts

(Continued from last issue)


Plant for Future Use

The company had much property not in use, mostly land and water rights, which it said “cost hundreds of thousands of dollars, and was worth millions,” and valued this property at $7,500,000.

As to this unused property Judge Farrington said in his opinion, October 7, 1908:

“If in this case the company, in anticipation of the growth of the city and its future needs, acquired property for future use at a cost of hundreds of thousands of dollars which is now worth millions, it has acted wisely, but it should be satisfied with the goodness of its bargain and the enhanced value of its property, without asking in addition gratuities from its customers in the way of higher rates. When the property does come into necessary service, the company is entitled to have it credited at its then fair and reasonable value for rate-fixing Purposes.” Spring Valley Water Company v. San Francisco, 165 Federal 667, 697.

In support of this view the opinion quoted Mr. Justice Harlan of the Supreme Court as follows:

“What the company is entitled to demand, in order that it may have just compensation, is a fair return upon the reasonable value of the property at the time it is being used for the public.” San Diego Land & Town Co. v. National City, 174 United States 739, 757.

The opinion in the present case also quoted Mr. Justice Holmes in a case where a water company had larger works than was necessary for its customers, as follows:

“If a plant is built, as probably this was, for a larger area than it finds itself able to supply, or, apart from that, if it does not yet have the customers contemplated, neither justice nor the Constitution requires that, say, two-thirds of the contemplated number should pay a full return.” San Diego Land & Town Co. v. Jasper, 189 United States 439, 446.

Franchise and Going Business

Judge Farrington made the following observations on the value of the franchise, going business and total property:

“The value of the franchise and going business depends upon their earning power. Their earning power depends on the rates, and the rates at the present time are regulated by the board of supervisors. If the board establishes rates higher than an adequate return for the physical plant requires, either by increasing the rate of income or by adding to the value of the plant itself, an earning power, and consequently a value, is thus given to the franchise and going business, in addition to and above the earning power and the value .of the physical plant.

“The water company’s system, in so far as it is now in service, and possibly in so far as it will be presently serviceable, is to be treated as a unit. It probably has a value as a whole which exceeds the sum of the values of its several physical elements and characteristics. That value is affected by the franchise, by the fact that the concern is a going business. The plant operated under a franchise, a legal right to collect water rates, is more valuable than without such a right; and a plant with an established business, with customers who have connected their houses with the company’s distributing pipes, is more valuable than it would be without such connections and without such customers. These facts, as well as all other discoverable elements of value, should be weighed, but it must be remembered that while the rate-fixing agency is in duty bound to establish rates which will afford a reasonable compensation for the use of this plant at a fair valuation as affected by the fact that it is a going business and operated under its franchise, there is no duty to go beyond this and confer an additional value for these intangible elements, which is neither discoverable nor apparent. If the franchise and going business have ever had a distinct, independent, productive value, it should appear somewhere or at some time in an exhibition of distinct earning power.

“At the present time, in fixing the probable, fair and reasonable value of the property, whether we consider the market value of the stock and bonds of the company before the beginning of the rate litigation, or whether we consider the original cost of the lands, water rights, and improvements, after weighing the increased cost of labor and materials, the deterioration of structures caused by use, and the ordinary action of the elements, and the fair increase in the value of real estate and water rights, as shown by recent prices paid for similar or the same property, it is not easy to escape the conclusion that the value fixed by the hoard of supervisors is too low; that the value fixed by Judge Morrow in the 1903 case, $26,752,500, was not then too high.” Spring Valley Water Company v. San Francisco, Supra, 695, 696, 702.

The Court then pointed out that while the preliminary injunction sought in 1903, 1904 and 1905 was to prevent a reduction of rates, the petition in the present case sought to restrain the city so that the company might increase its rates over those charged since 1902. In this situation Judge Farrington ordered an injunction to prevent enforcement of the ordinance rates, but required the company to impound with the Court all sums collected above the amount authorized by the ordinance, and to file a bond of $100,000 to cover possible damages.

(Continued on page 1408)

Water Works Awards and Values

(Continued on page 1399)

Spring Valley Valued by the Court—Lost and Unused Plant

Besides above property valued at $25,771,984, San Francisco Waterworks Company owned land, water rights and structures that had cost or had a value of $5,101,132, but were not used in 1904, as found by the Court. Furthermore, the Court found that plant which bad worn out or was no longer of any value had cost the company $2,100,199.59, so that the total figure for these worn out, abandoned and unused properties was $7,201,351.59. This last figure is the sum of the $3,752,432.26 for unused land and water rights and of the $3,448,918.64, for unused structures, shown by items in Tables 9 and 10 herewith, and consist partly of estimated value, in 1904.

Largest among the items of worn out and abandoned property was the original San Francisco City Water Works which went into the total at the cost of $1,261,198.34, or more than one-half the $2,100,199.59 for all worn out and abandoned plant. This City Water Works was the first to supply San Francisco, having begun to distribute water from Lobos Creek in 1857, and passed by consolidation into the property of the Spring Valley Company in 1863. With a drainage area of about ten square miles in the city limits, Lobos Creek maintained a constant flow of some 2,225,000 gallons daily for sixty years, but was abandoned as a source of supply in 1893, because of contamination. Some other large abandoned items of plant were the Locks Creek pipe line at $197,809, and the Pilarcitos flume and pipe line at $248,739, all as per Table 9.

Comparative Costs

For property used in 1904 the Court found reproduction cost at $28,957,028 as of that date, per Tables 1 and 8, and this figure plus the $5,101,132 for plant not in use gives a total cost of $34,058,160 for all property owned by the company that the Court considered of any value.

Table 8. Reproduction Cost of Spring Valley Waterworks Per Estimates of Engineers and per the Court, in 1911, as of 1903-1904.

Depreciation of $3,185,044.95 was deducted by the Court from its cost of $28,957,028 for useful property to get the value of $25,771,984, per Tables 1 and 2.

Comparison of reproduction cost per the Court with the costs of the water works property per the eight engineering estimates made by witnesses in the case may be noted in Table 8. Four of the engineers appeared for the company and four for the city, and each gave only the reproduction cost of the property to represent its value, except city estimate No. 1 on original cost, and no depreciation was deducted by either. Each estimate, including that of the Court, is separated into Land and Water Rights, Meters, Stock and Structures, and Going Value and Franchises, in Table 8. How much, if any, of the property was excluded from the engineering estimates because not in use does not appear in the opinion of the Court. As each of the engineering estimates places the value of the property at its cost, these estimates are compared with cost per the Court.

The largest variation appears in Land and Water Rights, which runs from $4,104,243 in city estimate No. 1 to $31,932,000 in company estimate No. 4, made by its chief engineer. For the reproduction cost and value of land and water rights in use the Court allowed $12,393,398.

Reproduction cost of Structures, Meters and Stock was found by the Court at $16,563,630, while the lowest engineering estimate was $13,942,086 by the city, and the highest was $19,649,000 by the company. For Going Value or Franchise, one city estimate contained $3,900,000, and one company estimate $5,671,509, but for these items the Court allowed nothing.

The highest estimate of cost was that of $51,669,000 for reproduction by the chief engineer of the company, and the lowest was that of $22,736,643 for original cost by the city. While the Court found reproduction cost at $28,957,028, it depreciated this figure to $25,771,984 as the value for the rate base.

Table 9: Cost of Structures Owned by San Francisco Waterworks But Used In 1904, As Found by the Court.

Besides above estimates of cost based on the inventory of the company property, several engineers estimated the value of the Spring Valley water works on the basis of the cost to procure an equivalent supply from other sources. Values based on estimated costs of sources of water supply outside of the Spring Valley system ran from $20,000,000 to $70,000,000, but the Court does not appear to have based any of its figures on this testimony. City estimate No. 4 included $1,400,000 for the “going business” and $2,500,000 for the franchise, making up the §3,900,000. Company estimate No. 1 included $5,671,509 for the “value of the going business,” and this sum was estimated to represent the amount by which the business failed to yield the current rates of interest on the investment from its beginning down to 1880. Valuations of company water rights by the engineers varied from $40,000 to $150,000 per million gallons of daily delivery. The Court took 33,000,000 gallons as the average daily delivery to San Francisco in 1903 and 1904, and valued the rights for this supply at $2,100,000, as appears in Table 5. At the daily consumption of 33,000,000 gallons, the value of $2,100,000 amounts to $63,636 per million gallons.

(To be continued)