Nobody disagrees that National Fuel Gas Co.’s utility business in Western New York is making good money.

The question now being debated by company executives and state regulators is whether National Fuel’s utility business is making too much money – and whether its 520,000 customers in New York are paying rates that are too high.

That debate is at the center of its ongoing discussions with state regulators over the rates it will be allowed to charge beginning in June.

National Fuel in late March proposed a new rate plan that would freeze its delivery charges for three more years, while instituting a new system that would allow it to earn a slightly higher return from its utility operations through a program that would split any earnings beyond its target with its customers.

That proposal, however, landed with a thud at the State Public Service Commission, which responded by taking steps that could impose temporary rates on National Fuel’s customers beginning in June while the utility goes through a traditional rate-setting proceeding that could take nearly a year to complete.

“National Fuel’s earnings level indicates that its gas rates may be higher than needed to provide safe and adequate service,” the commission said in ordering the utility to show why its gas rates should not be set on a temporary basis while a more thorough rate review takes place.

The notion of temporary rates is distasteful to National Fuel executives: With temporary rates, if the commission later decides that those interim rates are too high, it can invoke a state law that allows it to recover what it considers to be excess charges that were paid by National Fuel’s customers during the time that the temporary rates were in effect.

“I think this is a terrible signal from a regulatory policy point of view, and it discourages utilities and investors from making discretionary investment in New York State,” said Ronald Tanski, National Fuel’s chief executive officer.

Tanski argued that National Fuel is being penalized for doing a good job running its New York utility business, cutting costs and improving the efficiency of its operations while freezing the rates it has charged its customers since the beginning of 2008. The company has reduced its operating and maintenance costs by about 6 percent – or $10 million – since 2008.

“We’ve continually done a great job in this business, controlling costs and delivering great service to our customers,” Tanski said. “Our delivery rates are among the lowest in the state, and our gas costs are generally either the lowest, or among the lowest, in the state.”

But that improvement also has made National Fuel’s utility business much more profitable. While the company’s current rate plan set an earnings target equal to slightly more than 9 percent of its equity, National Fuel’s earnings over the past year have been equal to about 12.6 percent of its equity – almost 40 percent higher than that target.

And the PSC’s staff said it expects National Fuel’s utility profits this year to be at or near last year’s level.

“It suggests that maybe the rates are too high, to me,” said Gerald Norlander, the executive director of the Public Utility Law Project, an Albany-based group that represents low-income consumers.

“The company is not doing anything wrong here, and in fact, they’ve done the right thing and reduced their costs without reducing their service quality,” said PSC Commissioner Gregg Sayre. “But the way rate of return works, the commission does need to step in and take a look, when it appears that the utility is earning more than we think is appropriate, and that’s all that’s going on here.”

Exactly how profitable National Fuel’s utility business in New York is can vary, depending on how its returns are calculated. Depending on those assumptions, National Fuel said its earnings during the fiscal year that ended last September could be as low as an 11.9 percent return, while the PSC’s staff calculated the utility’s return at a much more lucrative 13.2 percent.

National Fuel doesn’t break down the earnings from its utility business by state, but those operations, which include its utility business in northwestern Pennsylvania as well as in New York, earned $57.4 million from October through March, a 21 percent increase from the year before, the company reported late last week.

Norlander speculated that National Fuel’s strong utility profits were the reason it proposed the addition of an earnings sharing mechanism in its March proposal.

“Apparently, the utility anticipated it would be called in for a rate review and sought to forestall rate case litigation with some concessions that were insufficient,” he said.

The National Fuel proposal would have allowed the utility to earn slightly less than a 10 percent return on its equity, but it added a provision that any earnings above that threshold would be shared equally with its customers.

The proposal recommended that the proceeds set aside for customers be used to fund National Fuel’s economic development program, promote the expansion of natural gas service in areas where it is too costly to serve, fund infrastructure investments and help pay for the replacement of its customer information system.

“I think it was very clear the company wanted to avoid a rate case,” Norlander said.

But the PSC said the company’s proposal didn’t go far enough. The commission said the proposal didn’t include “an adjustment to existing rates large enough to fully compensate for the imbalance between ratepayer and shareholder interests” since the company’s current rate plan took effect in 2008.

By raising the possibility that temporary rates could be put in place beginning in June, the commission is taking a step toward an interim set of delivery charges that leaves the door open for potential refunds to customers down the road.

The bills that National Fuel customers pay are made up of two components: the actual cost of the natural gas, which has plunged in recent years and is sold to consumers at cost, and the delivery charges that the company negotiates with the PSC. Those delivery charges, which are at the center of the discussions with the PSC, account for about 44 percent of an average customer’s bill.

While National Fuel’s delivery rates – which cover the company’s operating costs and profits – have been flat, the average residential customer’s bill, adjusted to account for fluctuations in temperatures, dropped by 38 percent – from $1,738 in 2008 to $1,075 last year – because of falling natural gas prices that resulted from the surge in production from shale gas formations, such as the Marcellus Shale in Pennsylvania.