State ex rel. Utilities Commission v. North Carolina Power

450 S.E.2d 896, 338 N.C. 412, 1994 N.C. LEXIS 705

• Court: Supreme Court of North Carolina
• Decided: December 9, 1994
• Docket: No. 230A93
• Status: Published

Opinions

FRYE, Justice.

This is an appeal from an order of the North Carolina Utilities Commission (Commission) in a general rate case involving Virginia Electric and Power Company (VEPCO) which operates as North Carolina Power (NC Power) in North Carolina and Virginia Power in Virginia. NC Power is a public utility operating under the laws of North Carolina and is engaged in the generation, transmission, distribution, and sale of electricity to the public for compensation.

Procedurally this case comes to this Court as follows:

On 31 July 1992, NC Power filed an application with the Commission to adjust and increase its rates and charges for electric service to its North Carolina retail customers effective 30 August 1992. The Commission ordered that $1.39 million of the capacity costs paid by NC Power to Ultra Cogen Systems (Ultra Cogen),¹ a cogenerator, be disallowed in calculating approved North Carolina retail rates. Cogeneration involves the simultaneous production of both thermal energy, such as heat or steam, and electrical power, usually at an industrial site. By making productive use of the excess heat produced in the generation of thermal energy, cogeneration can produce electricity at a reduced cost. Pursuant to section 210 of the Public Utility Regulatory Policies Act of 1978 (PURPA), regulations of the Federal Energy Regulatory Commission (FERC) promulgated thereunder, and implementation mechanisms of the states, electric utilities are required to purchase power produced by qualifying cogeneration and small power production facilities and are required to pay their “avoided costs” for the power unless another rate is negotiated.

In the spring and summer of 1986, NC Power was inundated with offers from cogenerators, that were Qualifying Facilities pursuant to federal law, to sell it electricity. In response, in December 1986, NC Power instituted a solicitation process and sent letters to potential sellers. One of NC Power’s letters was sent to Ultra Cogen.

On 30 January 1987, in response to this solicitation, NC Power received proposals from Ultra Cogen to sell power from nine projects. Based on numerous factors, including cost, NC Power informed Ultra Cogen in March 1987 that it was rejecting the offer. Between 12 November 1987 and 3 December 1987, Ultra Cogen initiated arbitration proceedings with the Virginia State Corporation Commission (VSCC) seeking to arbitrate NC Power’s rejection of its offer. Ultra Cogen requested the VSCC to order NC Power to enter into power purchase agreements. NC Power requested dismissal of the petitions on the ground that the VSCC had expressed its general approval of competitive bidding in a final order issued 29 January 1988. On 26 February 1988, the VSCC rejected NC Power’s motion to dismiss and designated Commissioner Thomas Harwood, Jr., of the VSCC as final arbitrator of the dispute. On 30 September 1988, Commissioner Harwood ordered NC Power to execute agreements with Ultra Cogen. This order was adopted by the entire VSCC on 18 November 19.88. In compliance with the VSCC’s orders, NC Power executed contracts with Ultra Cogen. Additional facts will be discussed where pertinent to the issues raised by NC Power.

The questions presented on this appeal are: (1) whether the Commission’s disallowance of $1.39 million in expenses for capacity payments for the Ultra Cogen cogeneration projects violates PURPA, N.C.G.S. § 62-133, or the Commerce Clause of the United States Constitution; and (2) whether the Commission’s exclusion of $28,000 in officers’ salaries violates N.C.G.S. § 62-133. We answer both questions in the negative and affirm the Commission’s order.

I.

As stated previously, section 210 of PURPA requires electric utilities to purchase power from qualifying cogeneration and small power production facilities. PURPA directs the Federal Energy Regulatory Commission (FERC) to prescribe rules to encourage cogeneration. These rules must insure that rates for such purchases shall be just and reasonable to electric consumers and in the public interest, and shall not discriminate against qualifying cogenerators. 16 U.S.C. § 824a-3(b) (1985). PURPA further requires that no rule prescribed for this purpose shall provide a rate which exceeds the incremental cost to the electric utility of alternative electric energy. Id. The “incremental cost of alternative electric energy” means the cost to the electric utility to produce or purchase the electric energy which, but for the purchase from such cogenerator or small power producer, the utility would generate or purchase from another source. Id. at § 824a-3(d). PURPA also provides that each state regulatory authority shall implement the FERC rule concerning purchases from cogenerators for each electric utility for which it has ratemaking authority. Id. at § 824a-3(f).

FERC regulations concerning the arrangements between electric utilities and cogenerators parallel the statutory provisions by requiring that rates for purchases shall be just and reasonable to consumers and in the public interest, and shall not discriminate against cogenerators. 18 C.F.R. § 292.304(a)(1) (1994). The regulations specifically provide that no utility is required to pay more than the avoided costs for purchases. Id. at § 292.304(a)(2). “Avoided costs” means the incremental costs which the utility would incur if it supplied the power itself or purchased it from another source. Id. at § 292.101(b)(6). The regulations further provide that they do not limit the ability of parties to negotiate agreements for rates and terms different from those called for in the regulations. Id. at § 292.301(b)(1). For example, a rate for cogeneration purchases may be less than the avoided costs if the state regulatory authority determines that a lower rate is consistent with the regulations and is sufficient to encourage cogeneration and small power production. Id. at § 292.304(b)(3). However, in April 1988, FERC held that it is impermissible for states to impose rates exceeding the avoided costs on wholesale purchases in interstate commerce. Re Orange and Rockland Utilities, Inc., 92 P.U.R.4th 1, 14-15 (1988).²

The United States Supreme Court has interpreted PURPA and the FERC regulations to mean that a state regulatory authority, in implementing PURPA and the federal regulations, must apply the avoided-cost rule in the absence of a waiver granted by FERC or a specific contractual agreement setting a price that is lower than the avoided cost. American Paper Inst. v. American Elec. Power, 461 U.S. 402, 76 L. Ed. 2d 22 (1983). Therefore, in this case, the VSCC was required to apply the avoided-cost rule in determining wholesale rates pursuant to PURPA and FERC regulations. While both parties in this case are in agreement that the avoided-cost rule is the appropriate method for determining wholesale rates pursuant to PURPA and FERC regulations, they.disagree as to what these avoided costs should have been. NC Power contends that when the VSCC set the price it had to pay Ultra Cogen for the wholesale power, the VSCC was implementing federal law and making a determination affecting wholesale power in interstate commerce. Furthermore, when the North Carolina Utilities Commission, in setting North Carolina retail rates, refused to allow NC Power to recover the $1.39 million that the VSCC required NC Power to pay Ultra Cogen, it unlawfully interfered with the VSCC’s implementation of federal law. We disagree.

NC Power relies on Nantahala Power & Light Co. v. Thornburg, 476 U.S. 953, 90 L. Ed. 2d 943 (1986), and Mississippi Power & Light Co. v. Mississippi ex rel. Moore, 487 U.S. 354, 101 L. Ed. 2d 322 (1988), in support of its arguments that North Carolina is preempted by Virginia’s decision. Those cases address the preemptive effect of a rate or apportionment set by FERC for a wholesale transaction subject to regulation under the Federal Power Act. Under FERC regulations, the purchase price for power sold by cogenerators is exempt from regulation by FERC under the relevant provisions of the Federal Power Act, 18 C.F.R. § 292.601(c), and the rate is determined under federal rules implemented by each state for utilities subject to their ratemaking authority. 18 C.F.R. §§ 292.304, 292.401(a). However, states cannot impose purchase rates in excess of avoided costs. Re Orange and Rockland Utilites, Inc., 92 P.U.R.4th 1, 14-15. Therefore, we conclude that the Commission’s disallowance of $1.39 million in expenses for capacity payments for the Ultra Cogen cogeneration projects does not violate PURPA to the extent it only excludes the amount above avoided costs.

We must now compare the VSCC’s determination of avoided costs with the Commission’s determination of avoided costs.

A. The VSCC’s Measure of Avoided Costs

On 27 April 1988, Commissioner Harwood ruled that Ultra Cogen was entitled to receive avoided cost payments determined as of 12 November 1987, the date Ultra Cogen began to file arbitration petitions with the VSCC. The Virginia arbitrator further concluded that the avoided cost payments should be based on NC Power’s costs of constructing and operating a gas-fired facility called Chesterfield Unit No. 7, which is intended to be the prototype for any new facility built through the mid-1990’s.

In an interim order of 27 May 1988, Commissioner Harwood specified various “key terms and conditions that should be included in a power purchase agreement between the parties.” These terms and conditions included the determination that the capacity price for each of the Ultra Cogen projects at issue shall be $341.23 per dependable kilowatt for the first fifteen years of operation and $189.70 for years sixteen through twenty-five. In a final order dated 30 September 1988, he ordered NC Power to execute agreements with Ultra Cogen including these terms. This order was adopted by the entire VSCC on 18 November 1988. In compliance with the VSCC’s orders, NC Power executed contracts with Ultra Cogen. NC Power did not exercise its right to appeal the VSCC’s order and it did not file the contracts with the North Carolina Utilities Commission. During the test year in this case, NC Power paid Ultra Cogen $2.8 million on a North Carolina retail allocation basis for capacity payments under these contracts.

B. The Commission’s Measure of Avoided Costs

On 26 February 1993 the Commission entered an order granting a partial rate increase finding that it was not bound by the actions of the VSCC with regard to the Ultra Cogen contracts and concluding that it was appropriate to reduce operation and maintenance expenses by $1.39 million to reflect the removal of unreasonable capacity costs.

The Commission compared the Ultra Cogen contracts to the results of the 1986 and 1988 competitive bidding solicitations and determined that the rates in the Ultra Cogen contracts exceeded NC Power’s avoided costs at the time the arbitration petitions were filed. The 1986 solicitation, which used NC Power’s proposed Chesterfield No. 7 as a benchmark, produced average capacity costs of $141 per dependable kilowatt compared to $341 per dependable kilowatt for the Ultra Cogen projects. The evidence showed that the 1986 projects were expected to operate at a 32.2 percent capacity factor compared to 27.1 percent for the Ultra Cogen projects, thus eliminating any justification for the higher capacity costs on the basis of lower energy costs.

The Commission noted that the Virginia arbitrator himself stated in a February 1990 order that payments for the Doswell projects (from the 1986 solicitation) were based on the avoided costs of Chesterfield No. 7 and were reasonable. The Doswell projects and the Ultra Cogen projects came on-line within a few months of one another (Doswell on 3 May and 10 May 1992 and Ultra Cogen on 22 February, 7 March, and 1 July 1992). The capacity cost for the Doswell projects is $146 per dependable kilowatt, while the capacity cost for the Ultra Cogen projects is $341 per dependable kilowatt. Furthermore, the Ultra Cogen projects’ average capacity factor, based on economic dispatch, is approximately one-half that of the Doswell projects’ average capacity factor, which indicates the Ultra Cogen projects’ energy costs are greater.

The seven projects that were selected in the 1988 solicitation and were operational at the time of the hearing, have an average capacity cost of $171 per dependable kilowatt and a combined capacity factor of 35.9 percent. The Commission used the average capacity costs from the 1988 solicitation as a proxy for what the 1986 solicitation results would have been if the 1986 solicitation had occurred at the time the Ultra Cogen contracts were signed. Using the results of the later solicitation did not prejudice NC Power, but rather allowed it to include $30 per dependable kilowatt (or $240,000) more in rates than if the 1986 results were used.

We conclude that it was not unreasonable for the North Carolina Utilities Commission to use the competitive bidding measure in determining avoided costs, thereby rejecting the measure used by the VSCC. In fact, NC Power argued before the VSCC that competitive bidding should be the measure used. The North Carolina Utilities Commission carefully reviewed the capacity rate set by the Virginia arbitrator’s decision and found that he did not properly take into account other potential sources of power. Thus, the Virginia arbitrator greatly overestimated NC Power’s avoided costs. The North Carolina Utilities Commission’s exclusion of $1.39 million in expenses for capacity payments for the Ultra Cogen cogeneration projects is nothing more than the disallowance of the amount by which the contract rate exceeded NC Power’s avoided costs. Therefore, there is no violation of PURPA.

Next, we address the question of whether the Commission’s dis-allowance of $1.39 million in expenses for capacity payments violates N.C.G.S. § 62-133. Section 62-133(b)(3) provides that the Commission shall determine a utility’s “reasonable operating expenses” when setting rates. NC Power contends that the Commission, contrary to North Carolina law, arbitrarily decided that the rates paid Ultra Cogen were too high. NC Power also argues that the Commission, in deciding the reasonableness of operating expenses, must determine whether management has acted prudently. We disagree.

This Court rejected this argument in State ex rel. Utilities Comm’n v. Carolina Power & Light Co., 320 N.C. 1, 358 S.E.2d 35 (1987), reasoning that:

[Although management prudence may be an important factor considered by the Commission in a general rate case, management prudence vel non does not control the Commission’s decision as to whether to adjust test period data to reflect abnormalities having a probable impact on the utility’s revenues and expenses during the test period, in order that it may set reasonable rates in compliance with N.C.G.S. § 62-133.

Id. at 12, 358 S.E.2d at 41. The conclusion that management imprudence is only one method of demonstrating that a given expense is unreasonable is also consistent with the standard applied in State ex rel. Utilities Comm’n v. Intervenor Residents, 305 N.C. 62, 286 S.E.2d 770 (1982). In Intervenor Residents, we held that the Commission must always determine that expenses paid to affiliated companies are reasonable. “If there is an absence of data and information from which either the propriety of incurring the expense or the reasonableness of the cost can readily be determined, the Commission may require the utility to prove [its] propriety and reasonableness by affirmative evidence.” Id. at 75, 286 S.E.2d at 778.

The findings of the Commission, when supported by competent evidence, are conclusive. State ex. rel. Utilities Comm’n v. Thornburg, 325 N.C. 484, 385 S.E.2d 463 (1989). In this case, the Commission reviewed the capacity rate set by the Virginia arbitrator and determined that he did not properly take into account other potential sources of power. Thus, his assessment of avoided costs was unreasonably high. The Commission’s exclusion of $1.39 million in expenses for capacity payments was merely the disallowance of the amount by which the contract rate exceeded NC Power’s avoided costs. Therefore, we conclude that the Commission properly disallowed expenses for unreasonably high payments to Ultra Cogen in accordance with N.C.G.S. § 62-133.

Another issue raised by NC Power is whether the Commission’s disallowance of these expenses violates the Commerce Clause of the United States Constitution. Under Article I, Section 8 of the U.S. Constitution, Congress shall have the power “[t]o regulate Commerce . . . among the several States . . . .” In FERC v. Mississippi, 456 U.S. 742, 72 L. Ed. 2d 532, reh’g denied, 458 U.S. 1131, 73 L. Ed. 2d 1401 (1982), the Court determined that Congress has the power under the Commerce Clause to regulate the relationships between cogenerators and electric utilities in order to protect interstate commerce. Under PURPA, federal law specifically requires each state to implement federal guidelines for each utility whose rates it regulates. 16 U.S.C. § 824a-3(f). Thus, the Commission is authorized by Congress to act with regard to arrangements between cogenerators and NC Power. The Commission’s disallowance of the amount by which the Ultra Cogen contracts exceeded NC Power’s avoided costs is consistent with PURPA and the FERC’s regulations and constitutes lawful retail ratemaking. The Commission’s actions here do not violate the Commerce Clause.

While we recognize that inconsistent determinations of avoided costs by the VSCC and the Commission may burden NC Power, we believe this burden is a necessary consequence of doing business in more than one state. Here, NC Power believed that the capacity rate set by the Virginia arbitrator and ultimately adopted by the VSCC was higher than required by federal law. In fact, NC Power argued before the VSCC that the competitive bidding method should have been used in determining avoided costs. However, instead of appealing the adverse decision of the VSCC to the Virginia courts, NC Power accepted the VSCC decision which required it to pay a rate in excess of avoided costs. NC Power thus accepted the risk that the North Carolina Utilities Commission might not permit it to recover the excess amount from its North Carolina consumers.

II.

Finally, we address the question of whether the Commission’s exclusion of $28,000 in officers’ salaries violates N.C.G.S. § 62-133. NC Power argues that absent a showing that such salaries are unreasonable or will not actually be incurred, there was no basis for the exclusion of these expenses. We disagree.

One of the critical elements of the ratemaking process is a determination of what expenses are appropriate for inclusion in rates. State ex rel. Utilities Comm’n v. Eddleman, 320 N.C. 344, 358 S.E.2d 339 (1987), and State ex rel. Utilities Comm’n v. Public Staff, 317 N.C. 26, 343 S.E.2d 898 (1986). The Commission argues that it is the policy of the Commission to make executive salary adjustments. See In re Application of Duke Power Co., 75 NCUC Report 298 (1985). In Application of Duke Power Go., the Commission concluded that Duke Power’s shareholders should bear fifty percent of the overall compensation of those officers whose functions are most closely linked with meeting the demands of the common shareholders. Id. The Commission has reached the same conclusion in subsequent rate cases. See, e.g., In re Application of Duke Power Co., 76 NCUC Report 279 (1986), and In re Application of Carolina Power & Light Co., 77 NCUC Report 272 (1987).

In the present case, the Public Staff proposed to remove fifty percent of the salaries of NC Power’s President/Chief Executive Officer, the Chairman of the. Board of Directors, and the President/Chief Executive Officer of NC Power’s sole common stockholder, Dominion Resources, Inc. The Commission concluded that the Public Staff adjustment to exclude fifty percent of the compensation of the three officers in question was appropriate, explaining its reasons for making the executive salary adjustments:

Witness Maness testified that these three individuals are closely linked to meeting the demands of the Company’s common shareholders. All three serve on the VEPCO Board of Directors, as well as the Dominion Resources, Inc. Board of Directors. The Chairman of the VEPCO Board is also the Chairman of the Dominion Resources, Inc. Board, as well as the boards of Dominion Resources, Inc.’s other subsidiaries, Dominion Capital, Dominion Energy, and Dominion Lands. Witness Maness testified that this adjustment is especially appropriate for VEPCO given the nature of Dominion Resources, Inc.’s non-regulated business interests. Witness Maness stated that the interests of Dominion Resources, Inc. as they relate to its non-regulated businesses may not always coincide with the interests of VEPCO’s retail ratepayers. Witness Maness also testified that the Commission has adopted an adjustment consistent with his approach in each of the seven Duke, CP&L, and VEPCO general rate cases decided since November 1984.

This Court will not disturb the Commission’s findings of fact which are supported by competent, material, and substantial evidence in view of the whole record and are not arbitrary or capricious. State ex rel. Utilities Comm’n v. Thornburg, 325 N.C. 484, 385 S.E.2d 463 (1989). The authority to regulate the rates of public utilities lies with the Commission and a reviewing court may not modify or reverse its determination merely because the court would have reached a different finding based on the evidence. State ex rel. Utilities Comm’n v. Eddleman, 320 N.C. 344, 358 S.E.2d 339 (1987). After reviewing the entire record, we conclude that there is substantial evidence to support the Commission’s salary adjustments in this case.

For the foregoing reasons, the Commission’s order of 26 February 1993 is affirmed.

AFFIRMED.

1 . Ultra Cogen Systems has been succeeded in interest by Hadson Power and later by LG&E Development. It will be referred to as Ultra Cogen in this opinion.

2 . Orange and Rockland Utilities reversed the FERC’s earlier position in the preamble to section 210 of PURPA. In the preamble, FERC stated in pertinent part:

If a State program were to provide that electric utilities must purchase power from [qualifying facilities] at a rate higher than that provided by these rules, a qualifying facility might seek to obtain the benefits of that State program. In such a case, however, the higher rates would be based on State authority to establish such rates, and not on [FERC’s] rules.

45 Fed. Reg. 12,214, 12,221 (1980).