Higgins, J.
The right of the State to regulate utility rates springs from the monopolistic character of the business authorized by its franchise. However, the management, operation, and control of the utility are primarily its own business. The purpose of regulation is to protect the public interest and see to it that adequate service is provided at reasonable rates. In return for the franchise, the utility gives up its right to make private rate contracts with its customers, and submits to the regulation of its rates. In exercising regulatory power, the Commission, acting for the State, must be fair both to the producer and to the consumer.
In fixing a rate the Commission must ascertain the value of the property used in providing service. “Necessarily, what is a ‘just and reasonable’ rate which will produce a fair return on the investment depends on (1) the value of the investment — usually referred to . . . as the Rate Base — which earns the return; (2) the gross income . . . from authorized operations; (3) . . . operating expenses . . . must include amount of capital . . . currently consumed in rendering the service; and (4) what rate constitutes a just and reasonable rate of return on the predetermined Rate Base.”
Utilities Com. v. State,
239 N.C. 333, 80 S.E. 2d 133;
Utilities Com. v. Greensboro,
244 N.C. 247, 93 S.E. 2d 151;
Smyth v. Ames,
169 U.S. 466, 42 L. Ed. 819; G.S. 62-124. “When these essential ultimate facts are established by findings of the Commission, the amount of additional gross revenue required to produce the desired net return becomes a mere matter of calculation.”
Utilities Com. v. State, supra.
The Commission found $18,400,000 to be the fair value of Piedmont’s property in carrying on its business in North Carolina. Piedmont contends the finding is not supported by competent, material and substantial evidence. It argues the Commission set out to have Piedmont absorb Transco’s rate increase. To accomplish this result the Commission accepted $1,104,000 (shown by the test period) as the net return. Likewise, it fixed six per cent as the proper rate of return. To justify both figures required a rate base of $18,400,000. As so fixed, the base is a quotient or a forced figure and is not supported by evidence. Piedmont further argues not only the figures but the concurring opinion of Commissioner Worthington and the dissenting opinion of Chairman Wescott support this view. Judge Campbell, in his order of remand, stated: “It would not be proper for the Commission to arrive at the fair value rate base by capitalizing earnings under the existing rates at the determined rate of return or by any such arbitrary calculations whereby rate base is a mathematical product or quotient from other determinations, instead of making, as the law requires, a true finding of the fair value of the property based
upon evidence of value independent of other determinations necessary in the proceeding.”
Piedmont claims, and Judge Campbell found, that the rate base of $18,400,000 was the result of calculation, using the company’s net profit for the test period, and six per cent as a fair return. These calculations fixed the base rate as stated above. If we disregard the foregoing claims, nevertheless errors of law appear in the Commission’s determination. These errors are sufficient to require that the proceeding go back for further consideration and findings. The order reveals the Commission disregarded altogether the evidence of replacement cost in arriving at fair value. Mr. Gannon, specialist in the field of utility accounting since 1937, using authoritative studies by which original cost may be translated into present value, actually fixed the value of Piedmont’s property at 32 million dollars. His calculations were based on studies of Piedmont’s cost record, as compared with nine other utility companies engaged in like activity in the Southeastern United States. In evaluating this testimony, the Commission said: “Even when performed by qualified engineers and based on actual inspection of the physical properties of the utility trended original cost studies have been accorded very little weight by the regulatory Commissions throughout the country.” (Quoting Southwestern Bell Telephone Co., 77 PUR. 33 (Mo.);
Re New Jersey Bell Telephone Co.,
72 PUR. 49;
Re Narragansett Electric Co.,
21 PUR. 3rd 113 (R.I.);
Re Montana-Dakota Utilities Co.,
28 PUR) 3rd 355 (Montana);
Re Central Illinois Elec. & Gas Co.,
6 PUR. 3rd 108).
“In this case Mr. Gannon freely admitted that he was not a qualified engineer, ... In short, his was a mere mathematical computation which he could have prepared in his office in New York. . . . Under these circumstances the probative force of the evidence of trended original cost which was admitted in this case is minimal, but we have not excluded it from consideration.”
In the case last cited by the Commission in support of its ruling,
Central Illinois Electric and Gas Co.,
6 PUR. 3rd 108 (Ill. 1954) the Illinois Commission stated: “Evidence of current or reproduction costs and of the observed condition or depreciation of the company’s electric, gas and water utility plants was presented by E. H. Gannon (here Piedmont’s witness) and L. N. Boisen of Stone & Webster Service Corporation . . . Gannon testified that the current or reproduction cost was determined by trending original costs by accounts and year of installation by the application of the Handy-Whitman Index. . . . While the evidence concerning trended. original cost and also concerning the observed depreciation may be open to challenge
in some minor respects
(emphasis added) such evidence does reflect a decrease
in the purchasing power of the dollar and the change in economic conditions and is pertinent to a determination of reproduction cost. Such trended cost must be considered and given appropriate weight in arriving at the fair value of the company’s utility plants.”
The Commission also cited
In Re Montana-Dakota Utilities Co.,
28 PUR. 3rd 355 (Mont. 1959) as authority for rejecting the trended original cost as evidence of present value. The case actually held: “While this certainly is a recognized method, we would hesitate to place entire reliance on the trended rate base.” These cases are far from holding the evidence is worth no more than “minimal” consideration.
In these times of increased construction costs and decreased dollar value, trended cost evidence deserves weight in proportion to the accuracy of the tests and their intelligent application. The objections to such evidence apparently came from jurisdictions where the base rate is fixed at “book value” or “original cost” rather than present value. Of course, the book value or original cost can be ascertained with exactness from the books and records. Trended cost is useful only when it becomes necessary to fix the present value of facilities constructed when the cost was low and replacement has become expensive — our case. The trended cost takes into account the type of facility, its age, its original and replacement cost, terrain, location, its probable useful life, and other factors.
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Higgins, J.
The right of the State to regulate utility rates springs from the monopolistic character of the business authorized by its franchise. However, the management, operation, and control of the utility are primarily its own business. The purpose of regulation is to protect the public interest and see to it that adequate service is provided at reasonable rates. In return for the franchise, the utility gives up its right to make private rate contracts with its customers, and submits to the regulation of its rates. In exercising regulatory power, the Commission, acting for the State, must be fair both to the producer and to the consumer.
In fixing a rate the Commission must ascertain the value of the property used in providing service. “Necessarily, what is a ‘just and reasonable’ rate which will produce a fair return on the investment depends on (1) the value of the investment — usually referred to . . . as the Rate Base — which earns the return; (2) the gross income . . . from authorized operations; (3) . . . operating expenses . . . must include amount of capital . . . currently consumed in rendering the service; and (4) what rate constitutes a just and reasonable rate of return on the predetermined Rate Base.”
Utilities Com. v. State,
239 N.C. 333, 80 S.E. 2d 133;
Utilities Com. v. Greensboro,
244 N.C. 247, 93 S.E. 2d 151;
Smyth v. Ames,
169 U.S. 466, 42 L. Ed. 819; G.S. 62-124. “When these essential ultimate facts are established by findings of the Commission, the amount of additional gross revenue required to produce the desired net return becomes a mere matter of calculation.”
Utilities Com. v. State, supra.
The Commission found $18,400,000 to be the fair value of Piedmont’s property in carrying on its business in North Carolina. Piedmont contends the finding is not supported by competent, material and substantial evidence. It argues the Commission set out to have Piedmont absorb Transco’s rate increase. To accomplish this result the Commission accepted $1,104,000 (shown by the test period) as the net return. Likewise, it fixed six per cent as the proper rate of return. To justify both figures required a rate base of $18,400,000. As so fixed, the base is a quotient or a forced figure and is not supported by evidence. Piedmont further argues not only the figures but the concurring opinion of Commissioner Worthington and the dissenting opinion of Chairman Wescott support this view. Judge Campbell, in his order of remand, stated: “It would not be proper for the Commission to arrive at the fair value rate base by capitalizing earnings under the existing rates at the determined rate of return or by any such arbitrary calculations whereby rate base is a mathematical product or quotient from other determinations, instead of making, as the law requires, a true finding of the fair value of the property based
upon evidence of value independent of other determinations necessary in the proceeding.”
Piedmont claims, and Judge Campbell found, that the rate base of $18,400,000 was the result of calculation, using the company’s net profit for the test period, and six per cent as a fair return. These calculations fixed the base rate as stated above. If we disregard the foregoing claims, nevertheless errors of law appear in the Commission’s determination. These errors are sufficient to require that the proceeding go back for further consideration and findings. The order reveals the Commission disregarded altogether the evidence of replacement cost in arriving at fair value. Mr. Gannon, specialist in the field of utility accounting since 1937, using authoritative studies by which original cost may be translated into present value, actually fixed the value of Piedmont’s property at 32 million dollars. His calculations were based on studies of Piedmont’s cost record, as compared with nine other utility companies engaged in like activity in the Southeastern United States. In evaluating this testimony, the Commission said: “Even when performed by qualified engineers and based on actual inspection of the physical properties of the utility trended original cost studies have been accorded very little weight by the regulatory Commissions throughout the country.” (Quoting Southwestern Bell Telephone Co., 77 PUR. 33 (Mo.);
Re New Jersey Bell Telephone Co.,
72 PUR. 49;
Re Narragansett Electric Co.,
21 PUR. 3rd 113 (R.I.);
Re Montana-Dakota Utilities Co.,
28 PUR) 3rd 355 (Montana);
Re Central Illinois Elec. & Gas Co.,
6 PUR. 3rd 108).
“In this case Mr. Gannon freely admitted that he was not a qualified engineer, ... In short, his was a mere mathematical computation which he could have prepared in his office in New York. . . . Under these circumstances the probative force of the evidence of trended original cost which was admitted in this case is minimal, but we have not excluded it from consideration.”
In the case last cited by the Commission in support of its ruling,
Central Illinois Electric and Gas Co.,
6 PUR. 3rd 108 (Ill. 1954) the Illinois Commission stated: “Evidence of current or reproduction costs and of the observed condition or depreciation of the company’s electric, gas and water utility plants was presented by E. H. Gannon (here Piedmont’s witness) and L. N. Boisen of Stone & Webster Service Corporation . . . Gannon testified that the current or reproduction cost was determined by trending original costs by accounts and year of installation by the application of the Handy-Whitman Index. . . . While the evidence concerning trended. original cost and also concerning the observed depreciation may be open to challenge
in some minor respects
(emphasis added) such evidence does reflect a decrease
in the purchasing power of the dollar and the change in economic conditions and is pertinent to a determination of reproduction cost. Such trended cost must be considered and given appropriate weight in arriving at the fair value of the company’s utility plants.”
The Commission also cited
In Re Montana-Dakota Utilities Co.,
28 PUR. 3rd 355 (Mont. 1959) as authority for rejecting the trended original cost as evidence of present value. The case actually held: “While this certainly is a recognized method, we would hesitate to place entire reliance on the trended rate base.” These cases are far from holding the evidence is worth no more than “minimal” consideration.
In these times of increased construction costs and decreased dollar value, trended cost evidence deserves weight in proportion to the accuracy of the tests and their intelligent application. The objections to such evidence apparently came from jurisdictions where the base rate is fixed at “book value” or “original cost” rather than present value. Of course, the book value or original cost can be ascertained with exactness from the books and records. Trended cost is useful only when it becomes necessary to fix the present value of facilities constructed when the cost was low and replacement has become expensive — our case. The trended cost takes into account the type of facility, its age, its original and replacement cost, terrain, location, its probable useful life, and other factors. Such evidence is not conclusive but it does appear to be a useful guide in determining value of facilities, most of which are underground and not open to visual inspection. Engineers and accountants have, through examination, investigation and experience in the field, devised tables, studies, and indices designed and intended as guides in translating original cost into present value. A better method, without minute underground examination, is not suggested.
Mr. Gannon’s evidence was competent and should have been considered by the Commission on its merits. The Commission, influenced no doubt by other commission holdings in original cost states, gave it only “minimal” consideration and further discredited it by saying it was not altogether ignored. Obviously the Commission brushed the evidence aside as of little or no consequence. We do not undertake to say what weight the Commission should have given Gannon’s and Muhlfeld’s evidence. What we do say is that it should have been weighed fairly in balanced scales. To give it minimal consideration only constituted error of law.
City of Richmond v. Henrico Co.,
185 Va. 176, 37 S.E. 2d 873, modified 185 Va. 859, 41 S.E. 2d 35;
Duquesne Light Co. v. Penn Public Utilities Comm.
176 Pa. Super. 568, 107 A.
2d 745 (1954);
Railroad Commission v. Houston Natural Gas Corporation,
289 SW 2d 559, 155 Tex. 502.
Piedmont’s witnesses, especially Mr. Watlington and Mr. Anderson, testified that six per cent on
•&,
rate base of $18,400,000 would not enable Piedmont to compete in the money market for the capital necessary to meet its expanding needs and to enable it to borrow money at a rate appealing to the sound investor rather than at a higher rate demanded by the speculator. In fixing the rate base the Commission appears to have used either its mathematical formula or its imagination instead of evidence to support the findings. The rate base fixed by the Commission is unsupported by competent, material and substantial evidence.
The trial judge also found error of law in the Commission’s refusal to allow Piedmont’s promotional expenditures as operational costs. Throughout its order the Commission recognizes the high quality of Piedmont’s management. The record shows the expenditure was actually made in its promotional activity. The Commission ordered the amount reduced by $186,000, this upon the basis of Cleveland’s evidence the percentage expenditure was in excess of the national average for companies retailing natural gas. No effort was made to ascertain the expenditures by companies in Piedmont’s class or in its territory. In this connection it must be remembered that Piedmont in 1952 changed over from manufactured to natural gas. All customers had to be sold on natural gas. New customers had to be won. Competition with electricity and oil had to be met. Piedmont is rapidly expanding its facilities by a heavy promotional program. Twenty per cent of its facilities were installed in the last year. Promotional expenditures throughout the nation included many old companies in the field for years with a well known product and an established market. Promotion in a new field faced Piedmont. It is doubtful for that reason whether evidence of the national average should be admitted at all. The average of companies in Piedmont’s classification, yes, but the national average, doubtful. The trended original cost evidence which we hold competent was based on the indices and studies of nine companies in Piedmont’s classification and in its territory. So Gannon’s and Muhlfeld’s evidence is not open to the national average objection.
For the purpose of establishing Piedmont’s proper rate base the Commission took the average net investment for the test year. Since rates are prospective, the base should have been determined as of the date the rates became effective. Piedmont is a rapidly growing company. Its investment was greatest at the end of the test year. Hence
the investment at that time should be accepted rather than the average for the year.
The Commission has found that six per cent on the investment is a fair net return. But six per cent is meaningless until it is translated into dollars and cents on the basis of a fixed amount of money — in this case capital structure or rate base. The evidence of Piedmont’s witnesses fixes the value as high as $32,000,000.00 and at all events greatly in excess of $18,400,000.00.
The Commission’s only witness, Mr. Cleveland, does not express any opinion as to the fair value of Piedmont’s capital investment. He does not qualify himself to give such opinion. He is an accountant who did nothing more than examine the books, make notes, go back to his office and prepare the charts used in his testimony. The books show only acquisition cost, and even the new construction is not included for the reason that “it is not yet producing income.” Neither does Mr. Cleveland ascertain the amount of capital consumed in operating the business.
On the record, we must agree with Judge Campbell’s finding that a rate base of $18,400,000 is not supported by competent, material and substantial evidence. We, therefore, agree with the Judge and Chairman Westcott that the proceeding should be remanded for such further study and up-to-date findings as will enable the Commission (1) to find the fair value of Piedmont’s facilities; (2) to ascertain its operating expenses, including capital consumed; (3) to fix such rate of return on the investment as will enable Piedmont by sound management to pay a fair profit to its stockholders and to maintain and expand its facilities and services in accordance with the reasonable requirements of its customers in the territory covered by its franchise.
Utilities Com. v. State, supra; Corporation Com. v. Mfg. Co.,
185 N.C. 17, 116 S.E. 178.
We have pointed out some of the particulars wherein we think the Commission has failed to follow the statutory rules as interpreted in our decided cases. In doing so we do not promulgate any new rules. Neither is it our intention to enlarge or restrict the application of old ones.
For the reasons indicated, the order of remand entered in the superior court is
Affirmed.