{ "id": 2516736, "name": "STATE OF NORTH CAROLINA EX REL. UTILITIES COMMISSION; and DUKE POWER COMPANY v. PUBLIC STAFF-NORTH CAROLINA UTILITIES COMMISSION (Appellant); and LACY H. THORNBURG, Attorney General; CITY OF DURHAM; and WELLS EDDLEMAN (Cross-Appellants)", "name_abbreviation": "State ex rel. Utilities Commission v. Public Staff-North Carolina Utilities Commission", "decision_date": "1988-07-28", "docket_number": "No. 108A87", "first_page": "689", "last_page": "709", "citations": [ { "type": "official", "cite": "322 N.C. 689" } ], "court": { "name_abbreviation": "N.C.", "id": 9292, "name": "Supreme Court of North Carolina" }, "jurisdiction": { "id": 5, "name_long": "North Carolina", "name": "N.C." }, "cites_to": [ { "cite": "69 PUR 4th 375", "category": "reporters:specialty", "reporter": "P.U.R.4th", "year": 1985, "pin_cites": [ { "page": "452" } ], "opinion_index": 0 }, { "cite": "333 S.E. 2d 259", "category": "reporters:state_regional", "reporter": "S.E.2d", "year": 1985, "pin_cites": [ { "page": "265" } ], "opinion_index": 0 }, { "cite": "314 N.C. 171", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 4694885 ], "year": 1985, "pin_cites": [ { "page": "179-80" } ], "opinion_index": 0, "case_paths": [ "/nc/314/0171-01" ] }, { "cite": "189 S.E. 2d 705", "category": "reporters:state_regional", "reporter": "S.E.2d", "weight": 2, "year": 1972, "pin_cites": [ { "page": "718" }, { "page": "732-33" } ], "opinion_index": 0 }, { "cite": "281 N.C. 318", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 8575227 ], "weight": 2, "year": 1972, "pin_cites": [ { "page": "337-38" }, { "page": "361" } ], "opinion_index": 0, "case_paths": [ "/nc/281/0318-01" ] }, { "cite": "343 S.E. 2d 898", "category": "reporters:state_regional", "reporter": "S.E.2d", "weight": 2, "year": 1986, "pin_cites": [ { "page": "904" }, { "page": "903-04" } ], "opinion_index": 0 }, { "cite": "317 N.C. 26", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 4779638 ], "weight": 2, "year": 1986, "pin_cites": [ { "page": "34" }, { "page": "34" } ], "opinion_index": 0, "case_paths": [ "/nc/317/0026-01" ] }, { "cite": "206 S.E. 2d 269", "category": "reporters:state_regional", "reporter": "S.E.2d", "year": 1974, "pin_cites": [ { "page": "276" } ], "opinion_index": 0 }, { "cite": "285 N.C. 377", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 8564942 ], "year": 1974, "pin_cites": [ { "page": "388" } ], "opinion_index": 0, "case_paths": [ "/nc/285/0377-01" ] }, { "cite": "197 S.E. 151", "category": "reporters:state_regional", "reporter": "S.E.", "weight": 3, "year": 1935, "pin_cites": [ { "page": "152" }, { "page": "152" } ], "opinion_index": 0 }, { "cite": "213 N.C. 660", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 8630066 ], "year": 1935, "opinion_index": 0, "case_paths": [ "/nc/213/0660-01" ] }, { "cite": "337 S.E. 2d 477", "category": "reporters:state_regional", "reporter": "S.E.2d", "year": 1986, "pin_cites": [ { "page": "482" } ], "opinion_index": 0 }, { "cite": "315 N.C. 127", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 4716956 ], "year": 1986, "pin_cites": [ { "page": "135" } ], "opinion_index": 0, "case_paths": [ "/nc/315/0127-01" ] }, { "cite": "358 S.E. 2d 339", "category": "reporters:state_regional", "reporter": "S.E.2d", "weight": 6, "year": 1987, "pin_cites": [ { "page": "380" }, { "page": "362" }, { "page": "346" }, { "page": "339" }, { "page": "362, n. 11" } ], "opinion_index": 0 }, { "cite": "320 N.C. 344", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 4729581 ], "weight": 4, "year": 1987, "pin_cites": [ { "page": "351" }, { "page": "355" }, { "page": "381" } ], "opinion_index": 0, "case_paths": [ "/nc/320/0344-01" ] }, { "cite": "74 PUR 4th 590", "category": "reporters:specialty", "reporter": "P.U.R.4th", "year": 1986, "opinion_index": 1 }, { "cite": "43 L.Ed. 1977", "category": "reporters:federal", "reporter": "L. Ed.", "year": 1898, "opinion_index": 1 }, { "cite": "171 U.S. 361", "category": "reporters:federal", "reporter": "U.S.", "case_ids": [ 3601172 ], "year": 1898, "opinion_index": 1, "case_paths": [ "/us/171/0361-01" ] }, { "cite": "169 U.S. 466", "category": "reporters:federal", "reporter": "U.S.", "case_ids": [ 3597602 ], "weight": 2, "year": 1898, "opinion_index": 1, "case_paths": [ "/us/169/0466-01" ] }, { "cite": "69 PUR 4th 375", "category": "reporters:specialty", "reporter": "P.U.R.4th", "year": 1985, "pin_cites": [ { "page": "452" } ], "opinion_index": 1 }, { "cite": "189 S.E. 2d 705", "category": "reporters:state_regional", "reporter": "S.E.2d", "year": 1972, "opinion_index": 1 }, { "cite": "281 N.C. 318", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 8575227 ], "year": 1972, "opinion_index": 1, "case_paths": [ "/nc/281/0318-01" ] }, { "cite": "358 S.E. 2d 339", "category": "reporters:state_regional", "reporter": "S.E.2d", "year": 1987, "opinion_index": 1 }, { "cite": "320 N.C. 344", "category": "reporters:state", "reporter": "N.C.", "case_ids": [ 4729581 ], "year": 1987, "opinion_index": 1, "case_paths": [ "/nc/320/0344-01" ] } ], "analysis": { "cardinality": 1288, "char_count": 45660, "ocr_confidence": 0.804, "pagerank": { "raw": 3.4060065401421095e-07, "percentile": 0.877714878357773 }, "sha256": "8083474ae5b0739e237281477ba4ee7e125736876097bd00f727d6ad44769265", "simhash": "1:041701c27de357e8", "word_count": 7323 }, "last_updated": "2023-07-14T21:30:38.561214+00:00", "provenance": { "date_added": "2019-08-29", "source": "Harvard", "batch": "2018" }, "casebody": { "judges": [], "parties": [ "STATE OF NORTH CAROLINA EX REL. UTILITIES COMMISSION; and DUKE POWER COMPANY v. PUBLIC STAFF-NORTH CAROLINA UTILITIES COMMISSION (Appellant); and LACY H. THORNBURG, Attorney General; CITY OF DURHAM; and WELLS EDDLEMAN (Cross-Appellants)" ], "opinions": [ { "text": "EXUM, Chief Justice.\nOn 27 March 1986, Duke Power Company (\u201cDuke\u201d) filed an application with the North Carolina Utilities Commission (\u201cCommission\u201d) seeking authority to increase annual electric revenues for its North Carolina retail customers by 14.7%, or $289,316,000. On 14 April 1986, the Commission declared Duke\u2019s application to be a general rate case, established the test period, and scheduled public hearings. Thereafter, the Attorney General, North Carolina Industrial Energy Consumers, the Commission\u2019s Public Staff, Carolina Utility Customers Association and Wells Eddleman intervened. On 31 October 1986, the Commission, Chairman Wells and Commissioner Cook dissenting in part, issued its Order Granting Partial Rate Increase, from which these appeals are taken, and which authorized Duke to increase its revenues for North Carolina retail customers by $133,080,000.\nOn intervenors\u2019 appeals the questions presented are whether the Commission erred in: (1) reaffirming its decision to allow Duke to recover, in rates charged to its customers, costs expended on its abandoned Perkins and Cherokee nuclear power stations; (2) deciding that 13.4% is a fair rate of return on Duke\u2019s common equity; (3) adopting Duke\u2019s actual capital structure as it existed on 31 July 1986 as a proper capital structure for rate-making purposes; and (4) failing to reduce Duke\u2019s equity capital for rate-making purposes by deducting from it Duke\u2019s investment in certain of its wholly owned, nonregulated subsidiaries. We hold that the Commission\u2019s conclusion regarding the appropriate rate of return on common equity is not supported by adequate factual findings, and we remand for further proceedings on this question. We affirm the Commission\u2019s decision on all other questions presented.\nI.\nThe Attorney General, the City of Durham, and Wells Eddleman contend the Commission erred in reaffirming its earlier decisions to allow Duke to recover from its ratepayers costs incurred in its now cancelled Cherokee and Perkins nuclear power station projects. Duke responds that our earlier decision, State ex rel Utilities Comm. v. Eddleman, 320 N.C. 344, 358 S.E. 2d 339 (1987), means this matter is res judicata and appellants are therefore barred from pressing this contention in the instant case. We agree with Duke and decline to address the merits of appellants\u2019 arguments.\nIn Eddleman we considered whether the Commission improperly allowed Duke to recover costs incurred in the construction of its abandoned Cherokee and Perkins nuclear power stations. Duke began constructing these stations in the mid-1970\u2019s in order to accommodate then predicted increases in electricity consumption. When consumption increases were not commensurate with these predictions, Duke\u2019s Board of Directors terminated construction of both plants. Duke sought, nevertheless, to recover in its rates costs, amortized over periods of years, incurred in the construction of these abandoned plants. The Commission, as it had done in the past without challenge on appeal, decided to permit this procedure. The Attorney General, the City of Durham, and Wells Eddleman appealed to this Court, contending for various reasons that the Commission\u2019s decision was legally impermissible. The Court, one Justice not participating, affirmed the Commission\u2019s decision by an evenly divided vote. Concerning the effect of our decision we declared, \u201cfollowing the uniform practice of this Court, the decision of the Utilities Commission is affirmed, not as precedent but as the decision in this case.\u201d Id. at 380, 358 S.E. 2d at 362.\nThe doctrine of res judicata treats a final judgment as the full measure of relief to be accorded between the same parties on the same \u201cclaim\u201d or \u201ccause of action.\u201d C. Wright, Federal Practice and Procedure, \u00a7 4402 (1969). \u201cThe essential elements of res judicata are: (1) a final judgment on the merits in an earlier suit, (2) an identity of the cause of action in both the earlier and the later suit, and (3) an identity of parties or their privies in the two suits.\u201d Hogan v. Cone Mills Corporation, 315 N.C. 127, 135, 337 S.E. 2d 477, 482 (1986).\nApplying the law enunciated in Hogan to the facts of the present case, we conclude, as a result of our Eddleman decision, that appellants are barred by the doctrine of res judicata from reasserting their claim that the Commission\u2019s treatment of the costs of the abandoned Perkins and Cherokee power stations is legally impermissible. Here and in Eddleman the parties and the claims are identical: the Attorney General, the City of Durham, and Wells Eddleman contend that the Commission erred in allowing Duke to include in its rates, on an amortized basis, costs incurred in the construction of its abandoned power plants. A final judgment on the merits of this claim was reached in Eddleman. Although our evenly divided decision had no precedential value, it operated, nevertheless, as the final decision in the case on this claim as to these parties.\nAppellants contend that because the Court in Eddleman was evenly divided there was no final judgment on the merits of their claim. This argument stands at odds with our decision in Seay v. Insurance Company, 213 N.C. 660, 197 S.E. 151 (1935). In Seay we held that when a judgment is affirmed on appeal because of an evenly divided Court, the lower decision becomes the law of the case and is determinative of the rights of the parties with regard to the fully litigated claim. Id. at 661, 197 S.E. at 152. Seay involved a claim by an insurance agent to recover commissions he contended the defendant company owed him. In the initial action the superior court reversed a judgment of nonsuit entered against the agent in municipal court. Defendant appealed, and this Court affirmed the superior court by an evenly divided vote. The agent brought a subsequent suit on the same claim against the insurance company\u2019s successor in interest, and again a judgment of nonsuit was entered against him. This Court reversed, holding that our earlier decision to reverse the judgment of nonsuit was determinative of the rights of the parties in any subsequent action on the same contract. Id. at 661, 197 S.E. at 152.\nSeay controls the present case on the res judicata point. While our decision in Eddleman to affirm the Commission has no precedential value, it does finally determine the rights of the parties in that litigation on the abandoned plant cost issue. Since those parties and that issue are the same as in the instant case, those parties may not here relitigate that issue.\nII.\nThe Public Staff argues the Commission\u2019s conclusion that 13.4% is a fair rate of return on Duke\u2019s common equity is not supported by adequate findings of material facts. We agree and remand for further proceedings on this issue consistent with this opinion.\nWe note at the outset that the Commission has labeled its determination that 13.4% is a fair rate of return on common equity a \u201cfinding.\u201d This, of course, does not make it so. What constitutes a fair rate of return on equity, as the Commission in other parts of its order recognizes, is ultimately a matter of judgment. Matters of judgment are not factual; they are conclusory and based ultimately on various factual considerations. Facts are things in space and time that can be objectively ascertained by one or more of the five senses or by mathematical calculation. Facts, in turn, provide the bases for conclusions. State ex rel Utilities Comm. v. Eddleman, 320 N.C. at 351, 358 S.E. 2d at 346. What constitutes a fair rate of return on common equity is a conclusion of law which must, in turn, be predicated on adequate factual findings.\nAll parties relied principally on what is known as \u201cdiscount flow methodology\u201d (\u201cDCF\u201d) to determine the appropriate common equity rate of return. According to this method the proper rate of return is determined by adding to the common stock\u2019s current yield a rate of increase which investors will expect to occur over time. C. F. Phillips, Jr., The Regulation of Public Utilities 356-57 (1984). While the use of DCF methodology presents some difficulties, especially in determining investor expectations, the parties in the present case agreed that a Duke-specific DCF is the best method for determining Duke\u2019s rate of return on common equity.\nDuke witness Dr. Charles E. Olson performed a Duke-specific DCF study which, standing alone, suggested a return requirement of 11.9% to 12.4%. He \u201cchecked\u201d the results of his study by performing a DCF study on a group of electric utilities comparable in risk to Duke. This study suggested a return requirement of 12.5% to 13.0%. Dr. Olson performed another check \u2014 a \u201crisk premium study\u201d \u2014 which suggested a return requirement of 13.75%. He acknowledged that the risk premium method is not as accurate as the DCF method. Dr. Olson\u2019s ultimate recommendation was for a 13.5% to 14.0% return on common equity.\nDr. Olson testified that in arriving at his recommendation he made two upward adjustments to the return requirement suggested by his Duke-specific DCF. The first adjustment was for the purpose of reimbursing Duke for the costs of issuing common stock in the future. Such costs are known as \u201cflotation,\u201d or \u201cfinancing,\u201d costs. The second adjustment was made to protect Duke\u2019s investors against dilution of their investment should Duke be required, during unfavorable market conditions, to issue stock below book value. Dr. Olson\u2019s financing cost adjustment would add one-half of one percent (.5%) and his \u201cdown market\u201d adjustment, an additional .5% to the rate of return on Duke\u2019s common equity otherwise suggested by his Duke-specific DCF. Both adjustments, when added to the rate of return otherwise suggested by Dr. Olson\u2019s Duke-specific DCF, result in a rate of return on common equity of 13.4%. Each adjustment translates into a cost of $21.2 million annually to Duke\u2019s North Carolina ratepayers. Together they add $42.4 million annually to these ratepayers\u2019 electric bills.\nPublic Staff witness George T. Sessoms testified that he performed DCF studies which suggested that a 12.3% return on Duke\u2019s common equity would be proper. He arrived at this figure by performing a Duke-specific DCF and a DCF analysis of a group of electric utility companies with risks similar to Duke\u2019s. The Duke-specific study indicated an investor return of 11.5\u00b0/o to 12.3%; and the study of the comparable group, 12.0% to 12.9%. From these ranges, Sessoms concluded that Duke\u2019s return requirement on its common equity should be 12.2%, only .2% less than suggested by Dr. Olson\u2019s similar, unadjusted, Duke-specific DCF. Sessoms then added .1% to this figure to compensate for those financing costs which, from Duke\u2019s past history of common stock issues, might be reasonably anticipated to occur in the future.\nAttorney General witness Dr. John W. Wilson recommended an 11% rate of return on Duke\u2019s common equity. He based his conclusion on a DCF study which employs a regression and correlation analysis of the historical growth rate of Duke and 79 other electric companies. Dr. Wilson made no adjustment for financing costs or down markets.\nThe Commission concluded that Duke should have the opportunity to earn 13.4% on its common equity. This is precisely the return suggested by Dr. Olson\u2019s upwardly adjusted Duke-specific DCF study. To support this conclusion the Commission recited the testimonies of witnesses Olson, Sessoms and Wilson. It highlighted the problems inherent in the DCF method of determining the required rate of return on common equity, emphasizing that the volatility characterizing then current stock market conditions may have skewed the witnesses\u2019 ultimate recommendations. The Commission noted that in the last general rate case Duke was allowed a 14.9% common equity return. It went on to declare that\nthe rate of return on common equity of 14.0% requested by the company is excessive, while the rates of return on common equity of 12.3% and 11% recommended by the Public Staff and the Attorney General, respectively, are too conservative and stringent and would severely handicap the Company in continuing to provide adequate and reasonably priced electric service to its customers.\nThe Commission did not state whether the 13.4% return included any adjustment for down markets. It did note that return included some adjustment for financing costs, but it did not quantify this adjustment.\nCommission Chairman Robert O. Wells, joined by Commissioner Ruth E. Cook, dissented from the Commission\u2019s decision to allow Duke a 13.4% return on its common equity. Chairman Wells expressed the view that the majority improperly included within the 13.4% return a .5% adjustment for financing costs and a .5% adjustment for down markets. Concerning the financing cost adjustment he noted:\nDuke issued new shares of common equity five times over the entire 10-year period of 1975-1985. The total cost of issuance was $16.1 million for an average cost per issue of $3.2 million. To permit Duke to collect $21.2 million annually to cover Dr. Olson\u2019s flotation cost fiction is totally unwarranted. However, . . . such a result is . . . implicit in the Majority having allowed Duke a 13.4% return on common equity. Mr. Sessoms added only one-tenth of one percent (.1%) for flotation costs. A .1% flotation cost adjustment will provide annual revenues of $4.2 million on a North Carolina retail basis. Such a sum will more than compensate investors for the costs of issuance of new common stock. Furthermore, the evidence is that Duke will not issue new stock in the foreseeable future. Therefore, whatever allowance is made for flotation cost will, in the foreseeable future, compensate investors for a cost Duke will not incur.\nRegarding an adjustment for down markets Chairman Wells wrote:\n[I]t is not the responsibility of this Commission, or of Duke ratepayers, to protect investors from swings in market price. The cost of Dr. Olson\u2019s down market adjustment to Duke\u2019s North Carolina retail ratepayers is another $21.2 million annually. The Majority, by allowing a 13.4% return on common equity, has in effect adopted a major portion of this down market adjustment. Again I note that Duke does not expect to issue any new common stock for the next three or four years. Indeed, the record reveals that Duke presently has surplus cash in excess of $400 million which could be used for capital expansion if needed.\nThe guidelines for determining a utility\u2019s rate of return in a general rate case are set forth in N.C.G.S. \u00a7 62433(b)(4). This statute provides that the Commission shall fix an overall rate of return on the cost of a utility\u2019s property as determined by subsection (b)(1) that will (1) enable a well-managed utility to produce a fair return for its shareholders, (2) allow the utility to maintain its facilities and services at a reasonable level, and (3) enable the utility to compete in the market for capital funds on terms that are reasonable and fair to its customers as well as its existing investors. See N.C.G.S. \u00a7 62-133(b)(4) (Cum. Supp. 1987). We have interpreted this statute to mean that\n[T]he Legislature intended for the Commission to fix rates as low as may be reasonably consistent with the requirements of the Due Process Clause of the Fourteenth Amendment to the Constitution of the United States, those of the State Constitution, Art. I, Sec. 19, being the same in this respect.\nUtilities Comm. v. Power Co., 285 N.C. 377, 388, 206 S.E. 2d 269, 276 (1974).\nThe overall rate of return is figured by combining the rates of return permitted on each form of capital accumulation, here long-term debt, preferred equity and common equity. In combining the rates of return each is weighted according to the ratio among the capital components of the company\u2019s capital structure, here 42.9% long-term debt, 10.8% preferred equity and 46.3% common equity. Here the proper rates of return were determined to be 8.91% for Duke\u2019s long-term debt and 8.27% for its preferred equity. When these are combined with the 13.4% return on common equity allowed by the Commission and all are weighted according to the ratios among all three forms of capital, the overall rate of return becomes 10.92%. It is this overall rate of return when applied to the rate base as determined by N.C.G.S. \u00a7 62-133 (b)(1) that produces the utility\u2019s required revenues.\nProper rates of return on debt and preferred equity are relatively easy to determine because they represent returns which, in effect, have been guaranteed to those who have furnished these forms of capital. These rates of return are sometimes called \u201cimbedded costs.\u201d The proper rate of return on common equity is always the most difficult to determine and becomes, as we have noted, essentially a matter of judgment based on a number of factual considerations which vary from case to case.\nThe proper rate of return on common equity is here an extremely important determination because, as can be seen, it is the most expensive form of capital accumulation, which expense is ultimately borne by the ratepayer, and it is the most heavily weighted in arriving at the overall return. It is important that a reviewing court be able to determine the factual underpinnings upon which the Commission\u2019s conclusion on this rate of return rests.\nN.C.G.S. \u00a7 62-94 prescribes the scope of appellate review of a decision by the Utilities Commission. According to this standard, the reviewing court\n(b) . . . may reverse or modify the decision if the substantial rights of the appellants have been prejudiced because the Commission\u2019s findings, inferences, conclusions or decisions are:\n(1) In violation of constitutional provisions, or\n(2) In excess of statutory authority or jurisdiction of the Commission, or\n(3) Made upon unlawful proceedings, or\n(4) Affected by other errors of law, or\n(5) Unsupported by competent, material and substantial evidence in view of the entire record as submitted, or\n(6) Arbitrary or capricious.\n(c) In making the foregoing determinations, the court shall review the whole record or such portions thereof as may be cited by any party and due account shall be taken of the rule of prejudicial error.\nN.C.G.S. \u00a7 62-94 (1982).\nIn order to facilitate appellate review, the Commission must comply with N.C.G.S. \u00a7 62-79(a), which provides that\n(a) All final orders and decisions of the Commission shall be sufficient in detail to enable the court on appeal to determine the controverted questions presented in the proceedings and shall include:\n(1) Findings and conclusions and the reasons or bases therefor upon all the material issues of fact, law, or discretion presented in the record, and\n(2) The appropriate rule, order, sanction, relief or statement of denial thereof.\nN.C.G.S. \u00a7 62-79(a) (1982). \u201cThe failure to include all the necessary findings of fact is an error of law and a basis for remand upon N.C.G.S. \u00a7 62-94(b)(4) because it frustrates appellate review.\u201d State ex rel Utilities Comm. v. The Public Staff, 317 N.C. 26, 34, 343 S.E. 2d 898, 904 (1986).\nWith these principles in mind, we hold the Commission did not comply with N.C.G.S. \u00a7 62-79(a) because it failed to include material factual findings sufficient in detail to permit meaningful appellate review of its conclusion that 13.4% is a fair return on common equity.\nFirst, we note that the Commission\u2019s approved rate of return coincides precisely with Dr. Olson\u2019s testimony as to the proper return suggested by his Duke-specific DCF study as he adjusted it to protect Duke\u2019s investors against down markets and to compensate for flotation costs. But the Commission made no findings as to whether it considered protecting Duke\u2019s investors against down markets in setting a proper rate of return on common equity, and if so, the extent to which this factor was employed.\nWhether and the extent to which the Commission utilized such a factor is material to its rate of return conclusion. There is no evidence in this record that Duke proposes or can be reasonably expected to issue common stock under market conditions which would cause the value of its outstanding stock to fall. At least in the absence of this kind of evidence a rate of return based, in part, on such a projected phenomenon would be improper. We agree with Chairman Wells that ordinarily \u201cit is not the responsibility of the ratepayers to protect investors from swings in the marketplace.\u201d Investors understand, and take the risk, that Duke might possibly at some time because of market conditions be required to issue shares at less than book value. But there is nothing in this record to show that such an event is contemplated or is a probability. Without such evidence we see no reason, nor has the Commission suggested any, for shifting the risk of possible stock issues in down markets from shareholders to ratepayers.\nTo attract capital, a utility does not need to charge, and is not entitled to charge, for its services rates which will make its shares . . . attractive to investors who are willing to risk substantial loss of principal in return for the possibility of abnormally high earnings. The reason is the utility, having a legal monopoly in an essential service, offers its investors a minimal risk of loss of principal.\nUtilities Comm. v. Telephone Co., 281 N.C. 318, 337-38, 189 S.E. 2d 705, 718 (1972).\nSecond, the Commission acknowledges that the rate of return is designed to compensate for financing costs. It states in its order, \u201c[t]he rate of return on common equity . . . includes an adjustment to allow for reasonable stock or issuance financing costs for the reasons generally stated by witnesses Olson and Sessoms in this case.\u201d But the Commission failed to quantify this factor, or to specify the extent to which this factor affected the ultimate rate of return approved. This again is a missing material factual finding. Because of its absence we are unable to say whether the Commission erred in its rate of return decision.\nSince no evidence was introduced that Duke intends to issue new stock for the next three or four years, and because there was no evidence regarding the probable cost of a prospective issuance, we question whether the record supports any financing cost adjustment. On the other hand, the record reveals that both Dr. Olson, testifying for Duke, and Mr. Sessoms, for the Public Staff, adjusted the rate of return derived from their DCF studies to account for future financing costs. The adjustments they suggested, however, .5% and .1% respectively, differ widely and amount to a significant difference to ratepayers. A .5% financing cost adjustment will increase rates by $21.2 million annually, while a .1% increase will cost ratepayers only $4.2 million annually.\nWe find nothing in the record which supports a $21.2 million annual adjustment for financing costs. The record shows that over the entire period of 1975-1985 the total cost of Duke\u2019s new stock issues was only $16.1 million. The average cost per issue was approximately $3.2 million. The only reference in the record to Duke\u2019s plans to issue stock in the future was the statement of its Chairman, Mr. Lee, that the company\u2019s \u201cpresent expectation is that we will be back into the capital markets for new funds in about three to four years.\u201d\nOn the basis of this evidence we agree with Chairman Wells that since the .1% financing costs adjustment suggested by Mr. Sessoms will provide annual revenues of $4.2 million, it will \u201cmore than compensate investors for the cost of issuance of new common stock\u201d presently contemplated by Duke. On the other hand, the .5% financing costs adjustment recommended by Dr. Olson would be, on this record, grossly extravagant and not justified.\nThus, even if the record supports some adjustment for financing costs, the extent of that adjustment is of considerable importance to ratepayers. It is a material fact which should have been specifically found by the Commission in order to permit meaningful appellate review of the Commission\u2019s ultimate rate of return decision.\nThe Commission, then, was required to make specific findings showing what effect, if any, it gave to financing costs or down market protection, or both, in arriving at its common equity rate of return decision. See Utilities Comm. v. Telephone Co., 281 N.C. 318, 361, 189 S.E. 2d 705, 732-33 (1972). Failure to do so constitutes an error of law requiring a remand for further proceedings. Id. at 365, 198 S.E. 2d at 735.\nOn remand the Commission is directed to reconsider the proper rate of return on Duke\u2019s common equity in light of this opinion. The Commission is directed further to support its conclusion on this issue with specific findings as to its treatment of financing costs and down market protection. The Commission may make such other findings of material facts in support of its conclusion on this issue as it deems appropriate.\nIII.\nThe Public Staff contends the Commission\u2019s decision that Duke\u2019s capital structure should include a common equity ratio of 46.3% is improper because it is not supported by substantial evidence. We disagree.\nThe ratios among common equity, preferred stock, and long-term debt used for rate-making purposes are important because of the relative expense to the utility of each form of capital accumulation. Common equity investors demand the greatest return; so, for the utility, this form of capital accumulation is, in terms of current expense, the most expensive of the three. The higher the common equity ratio, the greater the rates which must be charged to cover the expense of providing the higher return demanded by common equity investors.\nEvidence presented by Duke tended to show that its capital structure should be set so that the company could maintain between 45.0% and 50.0% common equity. Mr. William S. Lee and Mr. William R. Stimart testified that Standard and Poor\u2019s had recommended such a common equity ratio for AA rated utilities. Duke\u2019s application was for a capital structure based on its actual, per book capital structure as of 31 December 1985, consisting of 46.18% common equity, 10.97% preferred stock, and 42.85% long-term debt. In rebuttal, Mr. Stimart recommended that the Commission utilize Duke\u2019s actual capital structure as of 30 June 1986. This structure consisted of 46.49% common equity, 10.75% preferred stock, and 42.76% long-term debt. On cross-examination Mr. Stimart testified that Duke\u2019s capital structure as of 31 July 1986 included a common equity ratio of 46.3%.\nPublic Staff witness Sessoms testified that the capital structure requested by Duke was too conservative for rate-making purposes. According to Sessoms, Duke\u2019s capital structure was conservative in relation to the average capital structure of other publicly traded AA rated electric utility companies. He recommended a hypothetical capital structure of 45.0% common equity, 11.0% preferred stock, and 44.0% long-term debt.\nAttorney General witness Dr. Wilson recommended ratios of 42.17% for common equity, 11.17% for preferred stock and 46.66% for long-term debt. Dr. Wilson arrived at these figures by adjusting Duke\u2019s capital structure to omit what he considered to be equity invested in Duke\u2019s nonregulated subsidiaries, Mill Power Supply Company, Church Street Capital Corporation, Cresent Land and Timber, and Eastover Mining Company. Dr. Wilson testified that since these nonregulated enterprises produce an equity return for Duke, Duke\u2019s electric utility ratepayers should not be forced to subsidize them by including in Duke\u2019s capital structure for rate-making purposes Duke\u2019s equity investments in them.\nThe Commission concluded that Duke\u2019s actual capital structure as of 31 July 1986 represented an appropriate structure for this rate-making proceeding. This capital structure is composed of 42.9% long-term debt, 10.8% preferred stock, and 46.3% common equity. The Commission supported this conclusion by finding that the recommendations of the witnesses for the Attorney General and the Public Staff\nwould reduce Duke\u2019s common equity ratio below that which was approved in Duke\u2019s last general rate case; i.e., 45.52%. The evidence in this case does not support such a reduction. Mr. Lee, Dr. Olson, and Dr. Stimart all testified that S & P is increasing rather than decreasing the requirements for AA utilities and Dr. Olson testified that the tax reform act will have the effect of reducing Duke\u2019s fixed charge coverage ratio. The evidence in this case supports an increase rather than a decrease in Duke\u2019s common ratio.\nBased on considerations such as these the Commission decided that the capital structure as of 31 July 1986 was \u201cwithin the zone of reasonableness\u201d according to the evidence presented. The Commission stated finally that while it considered the capital structure of 31 July 1986 appropriate in this case it was concerned about Duke\u2019s increasing equity percentage. The Commission concluded that it \u201cbelieves that it is appropriate to place Duke on notice that the Company\u2019s actual capital structure will be closely scrutinized and examined for rate-making purposes in future general rate cases.\u201d\nChairman Wells dissented from the majority\u2019s decision concerning capital structure. He thought the majority failed to comply with its responsibility to fix rates as low as reasonably consistent with due process.\nTurning again to the standard of review established in N.C. G.S. \u00a7 62-94, we must determine \u201cwhether there is substantial evidence, in view of the entire record, to support\u201d the Commission\u2019s findings which, in turn, support its conclusion on the appropriate capital ratio for rate-making purposes. State ex rel. Utilities Comm. v. Eddleman, 320 N.C. at 355, 358 S.E. 2d at 339. Our function is not to conduct a review de novo. \u201cA reviewing court may not modify or reverse [the Commission\u2019s] determination merely because the court would have reached a different result based on the evidence.\u201d State v. The Public Staff, 317 N.C. at 34, 343 S.E. 2d at 903-04. On the contrary, a Commission\u2019s order\nwill not be disturbed if upon consideration of the entire record we find the decision is not affected by error of law and the facts found by the Commission are supported by competent, material and substantial evidence, taking into account any contradictory evidence or evidence from which conflicting inferences could be drawn.\nUtilities Commission v. Carolina Utilities Customers Assn., 314 N.C. 171, 179-80, 333 S.E. 2d 259, 265 (1985).\nWe find no error in the Commission\u2019s decision concerning Duke\u2019s capital structure. The testimony of Duke\u2019s witnesses Lee and Stimart supports the Commission\u2019s finding on changed economic conditions which, in turn, supports its conclusion that an increase, rather than a decrease, in the percentage of common equity from Duke\u2019s last rate proceeding is justified.\nIV.\nThe Attorney General argues that the Commission\u2019s decision regarding capital structure is improper because it includes equity capital which Duke has invested in certain of its wholly owned, nonregulated subsidiaries. He argues that to permit inclusion of equity capital Duke has invested in its nonregulated subsidiaries in determining the equity capital ratio for rate-making purposes is unlawful because (1) it permits the utility to earn a return on property not actually used in producing electricity in violation of N.C.G.S. \u00a7 62-133(b)(1) and (4); and (2) it is arbitrary and capricious in violation of N.C.G.S. \u00a7 62-94(b)(6) in light of the Commission\u2019s decision in an earlier proceeding to exclude from the capital structure the common equity invested in two of Duke\u2019s subsidiaries, Cresent Land & Timber Corporation and Mill Power Supply Company. See State ex rel. Utilities Comm. v. Eddleman, 320 N.C. 344, 381, 358 S.E. 2d 339, 362, n. 11. We disagree.\nThe flaw in the Attorney General\u2019s argument, as we see it, is that it assumes that when Duke invests in a subsidiary company the invested proceeds are derived wholly from capital accumulated by the sale of common equity. This, of course, is not the case. As we have noted earlier, capital is derived from the sale not only of common equity but from the sale of preferred stock and bonds. When proceeds from capital accumulated from all three sources is invested elsewhere, the assumption must be that these proceeds are derived from each source of capital in the same ratio as each source bears to the other on Duke\u2019s books. Thus, if any reduction in Duke\u2019s capital structure is to be made for rate-making purposes because of Duke\u2019s investment of some of its capital in nonregulated companies, the reduction must be made in each source of capital according to the ratio each source bears to the other. Such a reduction would effect no change in the ratios among the capital sources nor would it effect any change in the rate of return allowed for each component of capital.\nTo arrive at the level of income Duke is permitted to receive from its customers, the Commission first determines the utility\u2019s rate base, which is the original cost of all the utility\u2019s property used in producing electricity. It then allocates this rate base according to the ratio of its capital structure. Next it applies the rates of return allowed on each component of capital to that portion of the utility\u2019s rate base allocated to that component. See generally, N.C.G.S. \u00a7 62-133 (Cum. Supp. 1987). Whatever capital accumulated from whatever source Duke might have invested in unregulated subsidiaries, these investments have no effect on Duke\u2019s rate base upon which its permitted level of income is figured.\nThe result is that deducting from Duke\u2019s capital structure its investments in unregulated subsidiaries would have no ultimate effect on the determination of the level of income Duke is entitled to receive from its customers.\nIn Eddleman the Commission did adjust the equity component of Duke\u2019s capital structure by excluding Duke\u2019s investment in certain of Duke\u2019s nonregulated subsidiaries. Concerning this decision the Commission declared:\nDuke\u2019s capital structure should be adjusted to exclude the company\u2019s equity investment of $24,076,000 in two of its nonregulated subsidiaries (Cresent Land and Timber Corp. and Mill Power Supply Co.), particularly in view of the fact that the company has itself removed $21 million of long-term debt supporting such nonregulated subsidiaries .... It would clearly be inconsistent to exclude only the long-term debt portion of Duke\u2019s nonregulated investment in deriving the company\u2019s appropriate capital structure for rate-making purposes.\n69 PUR 4th 375, 452 (1985). In Eddleman it was necessary to adjust Duke\u2019s equity component in order to compensate for Duke\u2019s adjustment to its debt component. One adjustment necessitated the other in order to maintain an appropriate ratio between the two components for rate-making purposes.\nIn the present case there has been no adjustment to any capital component associated with Duke\u2019s investment in unregulated subsidiaries. Thus, the ratio among the components of Duke\u2019s capital structure remains constant. The rates of Duke\u2019s electric customers are not affected by inclusion or exclusion of capital invested in subsidiaries so long as the ratio among the components of the capital structure remains constant.\nThis is not to say that the Commission cannot, or should not, take into consideration, among other things, Duke\u2019s investment in unregulated subsidiaries in determining either an appropriate capital structure for rate-making purposes or an appropriate rate of return to be earned on Duke\u2019s rate base. We hold only that the Commission is not required, as a matter of law, to reduce the common equity component of Duke\u2019s capital structure by an amount equal to Duke\u2019s investment in its nonregulated subsidiaries in determining the appropriate capital structure for rate-making purposes.\nSummarizing, we hold the Commission erred only in failing to make sufficient material factual findings necessary to support its conclusion that 13.4% is a fair rate of return on common equity. This portion of the Commission\u2019s decision is reversed and the matter is remanded to the Commission for further proceedings consistent with this opinion. As to the other issues brought forward in these appeals, the Commission\u2019s decision is affirmed.\nAffirmed in part; reversed in part and remanded.", "type": "majority", "author": "EXUM, Chief Justice." }, { "text": "Justice Martin\ndissenting in part.\nI cannot agree with the approval by the majority of the Commission\u2019s treatment regarding the capital structure of Duke with respect to including equity capital that Duke had invested in its wholly owned, nonregulated subsidiaries. To this extent, I dissent from the majority opinion.\nI find that the Commission acted in excess of its statutory authority by including common stock investment in non-utility enterprises in determining the appropriate capital structure in this rate case. The majority argues that it must be assumed that when proceeds from capital are invested, the proceeds are derived from each source of the capital in the same ratio as each source bears to the other on Duke\u2019s books. Therefore, the majority argues, if any reduction in the capital structure is made for rate-making purposes, the reduction would be in each source of the capital according to the ratio each source bears to the other and in such case a reduction would not affect any change in the rate of return allowed for each component of capital. However, it appears to me that this solution is too simplistic. The point is that such investments in nonregulated companies should not be included for the purpose of determining the equity capital ratio for rate-making purposes. The law does not permit, for rate-making purposes, a utility to earn a return on property not actually used or useful in producing electricity. N.C.G.S. \u00a7 62-133(b)(l), (4) (Cum. Supp. 1987).\nSuch non-utility and nonregulated subsidiaries owned by Duke should stand on their own feet. They should produce an equity return for Duke, and Duke\u2019s ratepayers should not be forced to subsidize these enterprises by including Duke\u2019s equity investments in them as a part of the electric utility capital structure. By removing these investments, the evidence shows that the equity portion of the capital structure would be reduced from 46.9 percent to 42.17 percent. The effect on rates would have lowered the company\u2019s requested increase by some twelve million dollars. Thus, the evidence indicates that by including these investments as a part of the capital structure, the rate-payers are being saddled with an additional twelve million dollars.\nApparently the argument of Duke Power Company is that these investments represent current assets waiting to be reinvested in the electric plant. Even so, Duke\u2019s witness, Mr. Stimart, testified on rebuttal that if the Commission were to remove the equity portion of Crescent Land and Timber Company and Mill-Power Supply Company, the equity portion of the capital structure would be reduced to some extent. The Commission, however, made no adjustment to Duke\u2019s capital structure to remove the equity of any of the nonregulated subsidiaries. In so doing, it discussed only Church Street Capital Corporation. The Commission made no analysis as to why the equity investment in the other three major unregulated subsidiaries should not be removed. In this regard it is interesting to note that in 1985 this same Commission had removed from Duke\u2019s capital structure equity invested in Mill-Power Supply Company and Crescent Land and Timber Company. In re Duke Power Company, 69 PUR 4th 375, 452 (NCUC 1985). This Court agreed with that adjustment in State ex rel. Utilities Comm. v. Eddleman, 320 N.C. 344, 358 S.E. 2d 339 (1987).\nN.C.G.S. \u00a7 62-133(b)(4) compels the Commission to fix rates which reflect the return on the cost of property ascertained pursuant to subdivision (1) as will enable the public utility to produce a fair return for its shareholders. Subdivision (1) of the statute requires the Commission to fix rates by ascertaining the reasonable original cost of the utility\u2019s property which is used and useful in providing service rendered to the public within this state. The Commission, by including in the capital structure the equity Duke had invested in nonregulated subsidiaries, violates these statutory requirements. Smyth v. Ames, 169 U.S. 466, 42 L.Ed. 819, modified on other grounds, 171 U.S. 361, 43 L.Ed. 1977 (1898). See Utilities Comm. v. Telephone Co., 281 N.C. 318, 189 S.E. 2d 705 (1972).\nThe exclusion of such equity investments in nonregulated subsidiaries when determining capital structure of the utility is common practice in most jurisdictions. 64 Am. Jur. 2d Public Utilities \u00a7 156 (1972); In re New York Telephone Company, 74 PUR 4th 590 (N.Y.P.S.C. 1986).\nFurther, the Commission apparently reversed its prior holding concerning Mill-Power Supply Company and Crescent Land and Timber Company without making any analysis or discussion in this present proceeding. Thus, it appears that this decision was arbitrary and capricious and unsupported by the evidence upon the whole record test. In the 1985 proceeding, the Commission removed $24,076,000 of the company\u2019s equity investment in Crescent Land and Timber Company and Mill-Power Supply Company and assigned as one reason the fact that Duke had removed $21,000,000 of long-term debts supporting such nonregulated subsidiaries. In the present proceeding, we have a reversal without explanation, the Commission\u2019s order being silent as to why it reversed its previous ruling. Thus, it appears that the ruling is arbitrary and capricious and unsupported by the evidence.\nI find that the Commission erred as a matter of law by including Duke\u2019s equity investments in the nonregulated subsidiaries as a part of its capital structure in calculating the rate of return. Therefore, I would vacate the Commission\u2019s findings in this respect and upon remand have the Commission exclude Duke\u2019s investments in its nonregulated subsidiaries from the rate structure.", "type": "dissent", "author": "Justice Martin" } ], "attorneys": [ "James D. Little, Staff Attorney, for Public Staff Legal Division, North Carolina Utilities Commission, appellant.", "Lacy H. Thornburg, Attorney General, by Jo Anne Sanford, Special Deputy Attorney General, and Karen E. Long, Assistant Attorney General, for Attorney General Lacy H. Thornburg and City of Durham, cross appellants.", "Wells Eddleman, Intervenor pro se and cross appellant.", "Steve C. Griffith, Jr., Senior Vice President and General Counsel, and Ronald L. Gibson, Assistant General Counsel, Duke Power Company; Kennedy, Covington, Lobdell & Hickman, by Clarence W. Walker and Myles E. Standish, for Duke Power Company, appellee applicant.", "Richard E. Jones, Vice President and General Counsel, for Carolina Power & Light Company amicus curiae." ], "corrections": "", "head_matter": "STATE OF NORTH CAROLINA EX REL. UTILITIES COMMISSION; and DUKE POWER COMPANY v. PUBLIC STAFF-NORTH CAROLINA UTILITIES COMMISSION (Appellant); and LACY H. THORNBURG, Attorney General; CITY OF DURHAM; and WELLS EDDLEMAN (Cross-Appellants)\nNo. 108A87\n(Filed 28 July 1988)\n1. Appeal and Error \u00a7 68; Judgments \u00a7 37\u2014 Supreme Court decision \u2014 evenly divided Court \u2014 res judicata\nA Supreme Court decision by an evenly divided Court which affirmed a decision of the Utilities Commission allowing Duke Power Company to recover from its ratepayers costs expended on its abandoned Cherokee and Perkins nuclear power stations is res judicata as to such issue in this rate case involving the same parties.\n2. Electricity \u00a7 3; Utilities Commission \u00a7 42\u2014 electric rates \u2014 fair rate of return on common equity\nThe Utilities Commission\u2019s conclusion that 13.4% is a fair rate of return on Duke Power Company\u2019s common equity was not supported by adequate factual findings where the approved rate of return coincides precisely with the return suggested by a study conducted by Duke\u2019s expert witness as he adjusted it to protect Duke\u2019s investors against down markets and to compensate for financing costs of issuing common stock; the record does not support the adjustments made by Duke\u2019s witness; and the Commission failed to make specific findings as to whether the 13.4% return included any adjustment for down markets and the amount of the adjustment it made for financing costs. N.C.G.S. \u00a7 62-79(a) (1982).\n3. Electricity \u00a7 3; Utilities Commission \u00a7 41\u2014 electric rates \u2014 capital structure\u2014 common equity ratio\nThe Utilities Commission\u2019s decision that Duke Power Company\u2019s capital structure should include a common equity ratio of 46.3% is supported by substantial evidence where the testimony of two of Duke\u2019s witnesses supports the Commission\u2019s finding on changed economic conditions which, in turn, supports its conclusion that an increase, rather than a decrease, in the percentage of common equity from Duke\u2019s last rate proceeding is justified.\n4. Electricity \u00a7 3; Utilities Commission \u00a7 41\u2014 electric rates \u2014 common equity \u2014 investment in nonregulated subsidiaries\nThe Utilities Commission was not required, as a matter of law, to reduce the common equity component of a power company\u2019s capital structure by an amount equal to the power company\u2019s investment in its wholly owned, nonregulated subsidiaries in determining the appropriate capital structure for rate-making purposes.\nJustice Martin dissenting in part.\nAPPEALS pursuant to N.C.G.S. \u00a7 7A-29(b) from a final order of the North Carolina Utilities Commission entered 31 October 1986 in Docket No. E-7, Sub 408, by intervenors Lacy H. Thornburg, Attorney General; Public Staff, North Carolina Utilities Commission; City of Durham; and Wells Eddleman. Heard in the Supreme Court on 7 December 1987.\nJames D. Little, Staff Attorney, for Public Staff Legal Division, North Carolina Utilities Commission, appellant.\nLacy H. Thornburg, Attorney General, by Jo Anne Sanford, Special Deputy Attorney General, and Karen E. Long, Assistant Attorney General, for Attorney General Lacy H. Thornburg and City of Durham, cross appellants.\nWells Eddleman, Intervenor pro se and cross appellant.\nSteve C. Griffith, Jr., Senior Vice President and General Counsel, and Ronald L. Gibson, Assistant General Counsel, Duke Power Company; Kennedy, Covington, Lobdell & Hickman, by Clarence W. Walker and Myles E. Standish, for Duke Power Company, appellee applicant.\nRichard E. Jones, Vice President and General Counsel, for Carolina Power & Light Company amicus curiae." }, "file_name": "0689-01", "first_page_order": 733, "last_page_order": 753 }