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{{#Wiki_filter:QI RECT TESTiMGNY'octtetgp fO.Vao-VM-.Control+~'"''ate of Document AKGU T Y DOCKET FII.K CAROLINA POWER&LIGHT COMPANY Before the SOUTH CAROLINA PUBLIC SERVICE COMMISSION Docket Nos.18361-Application for General Increase 18387 ln Rates and Notice of Filing Change of Rates South Carolina Public Service Commission DIRECT TESTIMONY OF SHEARON HARRIS 1 2 A.5 Q.7 A.Please state your name, address and occupation.
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Shearon Harris.My office address is 336 Fayetteville Street, Raleigh, North Carolina, and my occupation is Chairman of the Board, President and Chief Executive Officer of Carolina Power&Light Company (CP&L).How long have you been associated with Carolina Power&Light Company and what positions have you held with the Company?I joined the Company in December of 1957 as Associate General Counsel and I became a Vice'President in 1960.I served as General Counsel from the latter part of 1962 until May of 1963 at which time I was 10 12 13 14 A.15 17 18 19 20 21 22 elected President.
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I was designated Chief Executive Officer in January 1969 and in March of 1970 I was elected Chairman of the Board.Would you briefly review some of your experience in the utility industry and in the business community.
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I have served as Chairman of the Edison Electric Institute, which is the trade association of the investor-owned electric utility industry, Chairman of the Board of Directors of the National Association of Electric Companies, Chairman of the Southeast Regional Advisory Committee of the Federal Power Commission, member of the Board of the National Association of Manufacturers and of the Executive Committee of the Business Round Table, and as an officer or active member of various other industry boards and committees.
                  'octtetgp fO.Vao-VM of Document
I am presently serving as Chairman of the Executive Advisory Committee for the National Power Survey conducted by the Federal Power Commission, Chairman of the Electric'ower Research Institute'\and serve on the Board of the United States Chamber of Commerce, and as a Trustee of the Committee on Economic Development.
                                            'ate AKGU   T Y DOCKET FII.K CAROLINA POWER & LIGHT COMPANY Before the SOUTH CAROLINA PUBLIC SERVICE COMMISSION Docket Nos. 18361 Application for General         Increase 18387   ln Rates and Notice of Filing Change of Rates
I am also a member of the Business Council.5 q.6 7 A.Would you describe generally the service area, the operating system and electr'ic facilities of CP&L.CP&L provides electric service at retail and wholesale throughout a 8 service area of about 30,000 square miles, covering the northeastern r area of South Carolina much of central and eastern North Carolina 10 and the Asheville area.The population of CP&L's service area is approximately 3,000,000.
At the end of March 1975, our retail customers 12 numbered approximately 663,000.About 86 percent of our revenues are 13 from retail service.At the end of 1975 the Company's generating 14 capability was about 6,800,000 kilowatts derived from seven coal-fired 15 16 steam electric plants, the Robinson nuclear unit, Brunswick nuclear unit No.2, thirty-three internal combustion turbine generators and four hydroelectric plants.During 1975 the Company's generation by 18 energy source was 72.5 percent coal, 22.4 percent nuclear, 3.8 percent hydro, 19 20 21 22 23.1 percent residual oil,.4 percent No.2 fuel oil and.8 percent natural gas.In 1976 the Company estimates its generation by energy source will be approximately 67 percent coal, 30 percent nuclear, and 3 percent hydro.The capability of our system including net power available on a firm commitment basis is about 7,000,000 kilowatts.
We also own and operate.24 25 an integrated transmission network and distribution system throughout I the service area.The Company's facilities are interconnected at various points with the systems of neighboring utilities in order to provide for an interchange of power.Our system and operations are more fully described in the 1975 Annual Report, which is presented here as"CP&L Harris Exhibit No.l." When was CP&L last granted general retail rate relief for its South Carolina operations?
7 A.The Company was last granted general retail rate relief in South Carolina in a case filed in October, 1973, by order of this Commission dated January 15, 1975 in a proceeding that was based upon a test 10 period ending December 31, 1973.11 Q~What has happened since the rate proceeding to the Company's credit 12 13 A.14 15 16 rating?In February of 1975 Moody's Investors Services, Inc., one of the nation's major rating agencies, downgraded CP&L's bonds from A to Baa.I know of no other time in the history of the Company that a major rating agency has assessed the quality of the Company's securities as below investment 17 grade.18 Q 19 A.20 21 Would you elaborate on the effects of the lower bond rating.The consequences of this lowered bond rating are far-reaching and continuing.
Many financial institutions and investors are now prohibited by their charters or by established policy from investing 22 4 23 in CP&L bonds.For example, pension funds for many public employees 5 are precluded by law from purchasing the Company's bonds as a result 24 of our low bond rating.Some institutions have been precluded from investing in our securities because of the low earnings coverage 26 of fixed charges which has been experienced.
During 1974 hearings in Docket No.17,134 Company witnesses predicted many harmful results should the Company's A/A bond rating be reduced.The results have been even more adverse than then anti-cipated.At that time, the Company was anticipating a spread between the cost of marketing A and Baa bonds of about 35 basis points.In April of 1975, after the downrating of CP&L's bonds in February, the Company sold$100 million in first mortgage bonds at a cost to the 10 12 Company of 11.24 percent.The most nearly comparable sile by a company with an A/A rating was that of Florida Power and Light Company at a cost of 9.08 percent, 216 basis points lower than CP&L was required to pay.We pointed out in the 1974 case that a Baa rating was certainly not one which would attract investor interest in 30 year 13 14 bonds.When we attempted in April of 1975 to issue bonds to mature in 30 years, we found that the interest in such bonds rated lower 15 16 than A by either of the major rating agencies was almost nonexistent.
Consequently, we had to shorten the maturity date from the normal 17 30 years to only nine years.18 19 20 21 22 23 24 25 26 We also pointed out in 1974 that a lowering of the Company's bond rating would result in a prompt reduction in the rating of the Company's preferred stock issues imposing substantially higher costs in raising this type of capital.This result has followed and the Company's preferred stock has also been downgraded by Moody's.In March of 1975 the Company sold preference stock at a cost of 11.2 percent.This compared to preferred stock sold in the same period by companies with A ratings for costs in the range of 10.25 percent to 10.36 percent.Our Company was unable to issue preferred stock at that time because 27 of low earnings coverage of preferred dividends and interest charges.
Not only has the lowered"rating resulted in higher costs for long-term financing, it has substantially increased the cost which 9 10 ll A.the Company would otherwise have to pay for short-term financing.
The Company's'ommercial paper rating was reduced from Prime 1 to Prime 2 at the same time the bond rating was reduced by Moody's.To have its securities rated at below investment grade is exceedingly costly to the Company and its ratepayers and will continue to be so for as long as this lower rating is in effect.Would you please state the objectives of the Company's present rate filing.Our overall objective is to improve the seriously deteriorated financial 12 condition of the Company so that we can regain, and once regained thereafter 13 14 maintain our credit worthiness and continue to provide reliable service to our customers.
Nore specifically, we are seeking increased revenues so that 15 16 18 19 20 21 Q.22 23 24 A.25 26 (a)the Company's earnings coverage of fixed charges can be restored and maintained at a more reasonable level of at least 2.5 times, (b)a fair and equitable return may be earned on the common equity investment in the Company, and (c)'the Company can continue the normal maintenance program that was reinstituted after the interim increases of 12 percent became effective on retail sales in the fall of last year.Would you please explain why the Company considers it important that its earnings coverage of fixed charges be increased and maintained at a level of at least 2.5 times?Because this is the minimum coverage which in the opinion of the Company will enable its bond rating to be restored to A/A.This is an opinion widely shared in the financial community.
1 Q.Would you please relate the Company's recent coverage experience.
2 A.The Company's earnings coverage of fixed charges fell below 2 times 3 for the 12 months ending October 1974, and notwithstanding the full effect of rate increases (based on 1973 test periods), it continued to remain below 2 times through July, 1975.This compares with earnings coverage of as high as 4.32 for the year 1968.As a resu1t of interim rate relief in the States of North Carolina and South Carolina last fall, the Company's earnings coverage increased to approximately 2.48 10.times for the 12 months ending March 31, 1976.This increasing trend is expected to level off soon even though we continue to collect all 12 13 14 15 16 17 18 W 19 20 21 of our requested increases subject to refund.While our earnings coverage may exceed 2.5 times for a brief period, it can certainly not be maintained there for an appreciable period unless the total rate relief requested in this filing is allowed.It is very important to note that the results for this period.are influenced greatly by the interim increases that have been in effect in North Carolina and South Carolina since last fall and by the full increases sought in both states which have been in effect during some part of that period.These revenues have been confirmed by the North Carolina Commission.
Should we not be able to recover our full requests here, our effort to regain and maintain our credit rating would be greatly frustrated..
Q.You have stated as a second objective in your rate case an increase in the rate of return to a more reasonable level.Is it your po'sition that the rate of return found fair and equitable in the last rate 4 case is inadequate?
A.I must answer that by first pointing out that because of attrition and a continued high rate of inflation, it has been impossible for the Company to earn the rate of return found by the Commission to be fair and reasonable.
The Commission's last rate order, based upon 10 a 1973 test period, concluded that the approved rates should permit CPGL to earn a 12.5%rate of return on its common equity, which rate 12 13 of return the Commission found to be fair and reasonable.
During the year 1975 the Company's actual rate of return on its portion of common equity applicable to South Carolina retail operations was 10 percent.15 This is substantially less than the rate of return which the Commission considered as just and reasonable in its order of January 15, 1975.16 17 18 19 20 21 22 23 24 25 As shown on the Company's revised Exhibit H, when appropriate adjustments are made this rate of return becomes less than 3 percent.A more specific answer to the question is that I do not consider the former rates of return allowed on common equity to be adequate under the circumstances presently existing.In the first place, during the past year it has been possible for purchasers of the Company's debt securities to obtain returns in excess of ll percent.Interest rates on long-term obligations have declined somewhat recently but will undoubtedly return to the high levels of last year as the demand for capital intensifies in the future.It is simply not realistic to 5 Q, 6 A.expect to attract equity capital on reasonable terms when the equity investor can from time to time obtain near1y comparable returns on other investments that are not faced with the challenges or the risks that , confront the utility industry today.What are some of the risks to which you refer?First, I will mention the deterioration that is occurring in the quality of earnings.A debate continues in the financial community over the extent to which earnings containing a high allowance for funds used during construction (AFDC)are of a lower quality than'earnings that 10 ll are less dependent upon such allowances.
In my opinion, while earnings resulting from AFDC are inferior, so long as AFDC does not comprise 12 13 an unreasonably large proportion of total net earnings the overall quality of earnings is not significantly affected.However, since AFDC provides 14 15 16 no cash flow, the risk exposure to investors in a company's securities increases when AFDC accounts for substantially all of the earnings of the company.CP&L has passed that point, and in fact the large amount 17 18 of AFDC included in CPSL's net income and the resulting small percentage of the Company's cash needs generated internally contributed to the 19 20 downgrading of its securities by Moody's.A study of the'5 major electrical utilities dated April 29, 1975, by Mitchell Hutchins, Inc., a research 21 22.23 24 25 firm highly respected in the financial community, showed CP&L as the only Company where AFDC exceeded net earnings available for common stock during the year 1974.This situation resulted from the large amount of construction work in progress upon which the Company realized no cash earnings.
As of the year end 1974, CP&L's construction work in progress amounted to$826 million or 75 percent of net plant in service.By May 31, 1975 construction work in progress,had increased to$948 million or approximately 86 percent of net plant in service.Thus, for every dollar of net investment of plant in service, the Company had, approxi-mately 86$invested in construction work in progress upon which it received no cash earnings.'t the year end 1975, construction work 10 11 12 13 in progress still amounted to$643 million, notwithstanding the fact Brunswick No.2 and related facilities, which accounted for$403 million came into service on November 3, 1975.AFDC increased to in excess of 100 percent of net earnings available for common-stock for the 12 months ending November, 1974, constituted 97 percent of earnings available for common for the 12 months 14 15 ending August, 1975, and continued at an exceptional 79 percent for the 12 months ending December 31, 1975.This means that in 1975, without 16 AFDC,.CP&L'had earnings of only$.57 per share., 17 18 19 20.The fact that the Company's operating revenues have not been producing sufficient earnings to service common stock is a risk factor which prudent investors must certainly consider in determining whether to invest in our stock or other securities.
21 Q.What are some of the other risks associated with owning electric 22 utility equities at the present time?e 23'.The delays and changes often involved in the licensing of generating 24 25 26 27 28 plants are unpredictable and costly.Uncertainties relating to environmental requirements, and potential costs associated with such requirements constitute risks.The more likely probability during.these times of high energy prices and often vocal consumer reaction that governmental or regulatory action (or inaction)will prove harmful
\is a risk which investors obviously consider.The possibility of adverse governmental and regulatory action constitutes risks which 3 today's equity investors consider.4 g.What rate of return are you requesting in this proceeding?
5 A.We are requesting rates that would produce additional revenue of 6'22,486,985 annually.Based upon the 1975 test period, this would yield a return of 12.18%on common equity.Because of attrition and continued inflation, we would expect to actually earn less than 9 this indicated test year return.10 As our expert, Dr.John Langum, testifies, the Company should actually earn a rate of return on common equity of 14.5%.This is the rate which he finds fair and reasonable and it is also the rate which the Company feels is)ustified.
12 13 Our original application in this case 14 was prepared to seek a return on equity of this amount.However, subsequent 15 decisions by the Company with respect to the normalization of certain 16 tax deferrals have resulted in a decline in the rate of return which the 17 requested rates would produce.18 Q.What consequences do you foresee from a failure to obtain the rate 19 relief requested in this proceeding?
20 A.A failure to obtain all of the relief would have serious adverse 22 23 effects of an immediate and long-lasting nature.Unless our A bond rating is restored by Moody's, it will be difficult, and perhaps impossible, to raise the amounts of capital required to continue our 24 25.26 27 presently planned construction program.Even if it is regained, it cannot be considered secure without the total increase-requested in this proceeding.
Consequently, should we fail to obtain the rate relief requested here, we would have to immediately review our construction program with a view toward reducing it further.Should we receive significantly less than the total relief requested, our bonds could be downrated even further-perhaps to a point'here our ability to obtain capital would be totally restricted.
The nation's governmental and corporate debt capital requirements are such that A or lower rated long-term debt funds will be often unavailable at any price.I think it fair to say that should we not regain our A/A bond rating, or should we regain it and fail to maintain it, our ability to raise necessary capital will be impaired to the point that more 10 11 12 13 14 construction delays will be necessary.
Should our bond rating deteriorate to a Baa/BBB the situation would become most perilous and substantial cutbacks in our construction program would immediately follow.Should our rating drop even lower than Baa/BBB, our construction pxogram would come to an immediate halt and mass future shortages of 15 electrical energy in our service area would be assured.There is no 16'ajor electric utility in the United States which Moody's rates below 17 19 Baa.Thus, a reduction in CP&L's rating to Ba by Moody's would effectively eliminate the ability of CP&L to raise funds in the capital market.20 Q.21 In past rate proceedings, certain intervenors have insisted that rates should not.be raised in order to construct plants for future use.Would 22 23 A.25 you please comment on this position.In requesting adequate rates, we are not requesting that today's rate-payer finance plants that will be used in the future.What we-are requesting is that rates be set so that our present costs, including the cost of a reasonable retuin on capital, be covered.,The rates which we are proposing are rates which are fair based upon our pr'esent plant in service.No lesser rates would be fair or adequate even if we did not have a construction program., The reason our construction requirements are emphasized is that unless our investors earn a fair rate of return, based upon today's plant in service and today's level 8'0 Q.11 A.12 13 of costs, our credit rating will not permit us to borrow.the necessary funds with which to continue construction activities which are essential in order to have power available in the future.Will you please briefly review your Company's present construction program.Our construction program, which is subject to continuing review, is shown on Harris Exhibit No.2.During 1975 our construction program underwent substantial downward revisions.
It is now tailored to the i~l=15 16 amount of capital which the Company reasonably hopes to attract assuming appropriate rate relief.Based upon present construction plans and the Company's revised load forecasts, the Company's generating reserve margin 17 18 19 20 Q.21 A.22 will drop to 4.9 percent in 1981, a negative 2.4 percent in 1982 and a negative.8 percent in 1983.It will return only to a positive 2.1 percent in 1984.What is the percentage of reserve capacity which your Company is planning?Up until 1974 the Company had a goal of 18 percent reserves.This was based upon reserve levels recommended by the Federal Power Commission and 23 considered adequate by the Company.However, during 1974 it became:24 25 evident to the Company that it would be unable to attract adequate capital to provide these reserve levels.It was therefore necessary to reduce j s 6 7 A.the level of planned reserves from 18 percent to 12 percent.We anti-cipate no difficulty in meeting this reserv'e criteria thro'ugh the year 1980.As pointed out in my answer to the previous question, however, the Company will be unable to provide even this minimum level of reserves after 1980 if the demand increases at the rate expected.What is the Company's demand forecasts for the next 10 years?We expect demand to increase by 7.4 percent annually during the next 10 years.This compares with an annual increase at a compound rate 10 of 10.4 percent over the 10 years ending in 1974.It is obvious that the construction now planned by the Company is a minimum construction 12 13 14 Q.15 16 A.17 18 19 20 21 program which will not maintain the Company's 12 percent reserve goal in certain future years unless the growth in demand increases by no more than an average of 6.5 percent over the next 10 years.Could it be that your growth forecasts are in excess of what should reasonably be expected?Our forecasts are based upon two studies-one conducted within the Company, and one conducted by a highly qualified outside consulting firm, Whereas, in past years we have tended to approve a mid-range of the upper and lower forecasts that have been proposed, our latest approved forecast accepts the lowest rate of growth suggested as probable by the studies.It would certainly seem imprudent to ignore 22 what these studies tend to show.In August of 1975 we had a peak 23 24 demand of 5060 megawatts, which is in excess of the 5001 megawatts we were projecting for 1975.It is the peak demand that determines the 25 amount of capacity which we must have available.
1 e.2 A.3.What growth are you experiencing in KWH sales'Our sales growth was slower in 1975 than expected although with respect to certain classes of customers it was in line with our projections.
As I have pointed out, our peak demand forecast 7 A.10 q.ll 12 A.13 14 15.did turn out to be conservative.
What" has been your sales increase to date in 1976'?Through March of 1976, usage by our customers increased by almost 13%over that of the first quarter of 1975;Should this continue, our 1976 sales forecast would prove overly conservative.
How has your Company's load factor been affected by recent kilowatt-hour sales experience?
As peak demands have continued to increase while kilowatt-hour sales remained relatively flat, we have seen a natural deterioration in our load factor.This has not been in the interest of the ratepayer or'he Company.17 A.18 Would you please describe your Company's future capital requirements.
Although our construction program has been reduced considerably, the capital requirements remain enormous.$6.3 billion will be required over the next 10 years.$826 million is necessary for the years 20 21 1976-78, and a substantial portion of this must be raised through the public sale of capital stock and first mortgage bonds.22 23 As a result of inadequate earnings, the Company's last three common stock issues had to be sold below book value.This means that 37 percent of the common shares now outstanding has been sold below 2 3 book value and although there has been an improvement in the price of our stock as the stock market generally has improved, it continues to sell below book value.The dilution in the value of common stock owned by investors at the time of those sales has been substantial.
The Company must again sell common stock in the fall of this year.Should these applications not be allowed in their entirety, and should the Company be forced to make refunds of amounts already collected, we would not expect a successful stock sale.Mr.Harris, one of the three objectives of this rate case,'hich you mentioned at the beginning of your testimony, was that the Company be 12 able to continue normal maintenance.
Would you elaborate on this, please.13 A.Yes.A part of the rate increase requested is to continue our normal maintenance program which we were able to reinstitute after interim 15 retail increases became effective last fall.Normal maintenance 16 17 18 20 21 A.22 is now underway pending the outcome of this general rate request.Unless all of the relief requested in this fi.ling is a11owed, it wil1 be necessary for us again to defer some maintenance expenditures.
Why did your Company ever depart from what you term a"normal maintenance program"?ln 1974 it became apparent that the rate relief sought in applications filed in October 1973 would not be sufficiently timely nor adequate to restore earnings to a level where the Company's securities would be attractive to investors and could be sold on reasonable terms.Consequently, in order to preserve the Company's financial integrity and to be able to continue to finance its construction program, we went beyond our on-going cost control program and inaugerated an emergency expense curtailment program, which was designed to delay or eliminate costs.This program was called to the Commission's attention during testimony in rate hearings in 1974.The program eliminated some reasonable and proper expenses and deferred some essential expenditures pending an improvement in the 9 10 Company's financial condition to a point.where its A bond rating would be less insecure and it could market common stock and other securities on reasonable terms.However, notwithstanding vigorous cost reduction 12 efforts the Company's coverage of fixed charges dropped below 2 times to 1.92 times at year end 1974.In February 1975, the Company's bond 14 15 16 17 rating was reduced from A to Baa by Moody's Investors Services, Inc.and we have not recovered financially to a point where delayed and'I badly needed expenditures can be resumed without further threat to our financial stability.
In early 1975 it became necessary to further reduce our level of maintenance to partially compensate for revenues 19 lost when the North Carolina Commission restricted collections under 20 21 22 23 24 the fuel clause, and for the further purpose of attempting to raise our earnings coverage of fixed charges to a level where we could continue to market securities without having to pay exorbitant prices.That level of maintenance continued until our interim retail rate increases were placed into effect last year.
1 Q.To what do you attribute your Company's present financial condition and the fact that it has been unable.to earn the rates of return allowed by this Commission?
4 A.10 12 13 14 16 There are four major cost factors, all of which are beyond our ability to absorb or defer, that have led to our present depressed financial condition.
The first factor is a continuing high rate of inflation which affects electric utilities to a greater extent than industry generally.
Our present rates, as the Commission is well aware, were based upon costs in a 1973 test year.A second factor which I will mention-and a most major factor-is the cost of capital.The cost of capital obtained on a long-term basis has continued to increase.The$100 million in First Mortgage Bonds which we issued in April of 1975 was at a cost of 11.24%.This compares to an average cost for bonds issued in the former test year of 1973 of less than 8%.At the end of the last test period, the average interest rate of, the Company's First Mortgage Bonds was 17~6.78%.By December 31, 1975 this had increased to 7.72%.On December 31, 18 19 20 1973 the average dividend rate on preferred stock was 7.24%on the preferred stock outstandin
.In March of 1975 we issued preference g stock at a cost to the Company of 11.21%.As I have previously mentioned, 21 22 23 we were unable to issue preferred stock at this time because our earnings were insufficient to meet the earnings coverage requirements of our charter.The average dividend rate on preferred and preference stock 24 25 is now 8.06%, having risen 11%over the average dividend rate on December 31, 1973.The cost of servicing common equity has'also increased significantly as we have been forced to sell additional common stock at below its book value.En our last rate case, I testified that in November, 1973 we were required to sell 3,000,000 shares of common stock at a"distressed price." That stock sold for'$21.25 per share, and netted to the Company proceeds of.$20.31 per share after underwriting discounts.
Since that time, we have sold 4,000,000 shares of common stock"in January 1975 at a price of 10 13$14.75 per share, 31%less than the$21.25 per share of, the November 1973 issue.The net price was'nly$14.00 per share.In October 1975 we sold 5,000,000 shares of cpmmon stock at$17.'875 a share, 23%less than the$23.34 book value.The net price was only$17.215 a share.A third factor has been expenditures which we have made," and are continuing to make in increasing amounts, for environmental protection..
15 16 17 18 19 20 Since the beginning of 1972, we have invested over$84 million in devices to protect-air and water.We are spending about$30 million annually for systems that do not add to our capacity-indeed many use substantial quantities of energy.Consequently, the cost we experience is not limited to the cost of servicing the capital required to install the systems and devices;our cost of producing electricity 22.for sale increases since a portion of our gener'ation must be used to operate some of the environmental devices.We simply cannot absorb the tremendous costs involved.When we filed our last rate case, in October of 1973, we firmly believed that the cooling system then planned for the Brunswick Nuclear Plant was not only adequate, but was acceptable to state and federal regulatory authorities.
Since that time, we have been ordered to install cooling towers at a cost of 10 ll 12 over$72 million.We are attempting to avoid this requirement as we feel that it is a useless expenditure of the electric consumers money.I However, it has been necessary for us to beginiconstruction of the cooling towers, and whatever costs are ultimately incurred will have to be recovered through increased rates.A fourth major factor is attrition.
Cost of building power plants and other facilities has increased dramatically, and as new facilities are brought on line and into the rate base, it is necessary that costs associated with them be recovered.The cost of our Robinson Nuclear Unit completed in 1971 was about$127 per kilowatt capacity.Our Brunswick No.2 plant, which entered commercial operation in November of last year cost about$485 per kilowatt capacity.While decreased 18 19 fuel costs associated with this nuclear plant means lower overall rates to the consumer than would be possible with other forms of 2O n 22 23 24 generation, the capital and other fixed costs associated with this generating plant have to be recovered through increased base rates.As new and more expensive facilities become a part of the Company's rate base, the capital and other fixed costs associated with generating electricity increases accordingly.
What action has your Company taken to reduce its expenses?2 A.The Company continues a vigorous cost control-earnings improvement 3 program which eliminates or defers expenses for items that are necessary 4 5 6 7 and proper business expenses in the sense that they are desirable and reasonable
-but are of the nature that they can be postponed indefinitely or delayed.As a part of its regular business practice the Company has always maintained a cost control program in every department, and the prevention of unnecessary cost has always been an item of top priority with the Company's management.
The commitment of the Company to"frugality" is well known to all who have ever been associated with effect, however, goes beyond the Company's tradition of austerity.
ll its operations.
The expense curtailment program which is now in 12 13 14 15 16 17 18 19 For instance, no new personnel may be employed without the specific approval of me as Chief Executive Officer.I do not approve the filling of any vacant positions unless it is demonstrated that the I new employee is absolutely essential in order to assure that necessary tasks can be carried forth.Budget restraints have been imposed on all departments.
Moreoever, we have organized within the Company a Corporate Performance Review Department.
Among its 2O duties is the responsibility of analyzing the performance of 21 22 23 24 25 the various facets of our Company's operation and comparing them with those of other companies.
If other companies are out-performing CP&L in any area, the responsibility of this Department is to determine why.If any other similarly situated company is doing anything more efficiently and at less cost than this Company, we' want to know about it and can assure'he Commission that we wi11 implement any changes necessary that might improve our performance 3 even further.4 Q.Is your corporate analysis far enough along to give any indication
'5 of how your Company compares with other similarly situated companies?
6 A.Yes indeed.'ur total operations compare most favorably with those of the industry generally and with eight similar southeastern investor-owned companies with which we have made comparisons.
For instance, the Company's total operating expenses and interest charges per kilowatt-10'1.12 13 14 hour of energy sold was less than that experienced by six of the other seven comparison companies during the year 1974.Stated another way, we delivered more kilowatt-hours per dollar of total operating expenses and interest charges than did all but one of the other comparison companies.
A study of the 50 largest investor owned electric utilities 15 in the country shows that while CP&L was 28th from the largest customer 16 17 18 19 20 21 Q.22 wise, in 1970, 26th in 1971, and 25th in 1972, its operations and maintenance expenses per kilowatt-hour sold were"32d.from the highest in 1970, 34th in 1971, and 39th from the highest in 1972.Complete~figures are unavailable for subsequent years at the present time;however, we believe that the trend is continuing.
Are you familiar with the recent comparison study of electric utilities released by the National Association of Regulatory Utility Commissioners?
23 A.Yes.Me have received copies of the report and have analyzed it.It confirms our own studies and shows that our Company compares most 25 favorab1y" with other companies.
in every area studied.
1 Q.Would you have any objection to a management audit of your Company 4 2 by an outside consulting firm?3 A.None whatsoever.
I have stated publicly on any number of occasions that we would welcome such an audit.The North Carolina General Assembly has authorized the North Carolina Utilities Commission to order audits once every five years with the expense being paid by the companies and recovered through rates.The Commission has recently employed the firm of Booz, Allen and Hamilton to conduct a review of our Company and I would expect this firm's 10 11 12 findings to be made available to the South Carolina Commission and to the public.By the time we have hearings in these proceedings this review should be well underway.We are confident that the audit will reveal that we are managing efficiently.
Is your Company asking for a continuation of the fuel clause?A.Yes.The details of our recommendations are contained in the testimony 14 of other witnesses.
Q.Do you consider a continuation of the fuel clause necessary in view of the fact prices have stabilized?
18 A.By all means.Fuel costs comprise such a large portion of our operating 19 expenses that even slight fluctuations amount to tremendous sums of money.20 If the fluctuations are downward the customers should receive the benefits.21 If they are upward, the Company must cover its cost.Moreover, we are 22 sta.ll subject to immediate and extreme upward fluctuations in fuel prices 23 which cannot be accommodated through traditional forms of rate hearings.25 Finally, the introduction of larger percentages of nuclear generation on our system means that monthly costs of fuel will vary significantly even if fuel prices remain level.This is because nuclear fuel is so, much less expensive than fossil fuel.In nuclear generation fuel cost will be months when we get substantial
'1 down.However, in months when nuclear plants are out for refueling or sub)ect to other outages fuel costs will increase appreciably.
We are of the firm opinion that a fuel ad)ustment clause is a fair and equitable means of compensating 7 for fuel cost fluctuations.
Q.Mr.Harris, would you please summarize your testimony.
9 A.My testimony essentially is that notwithstanding rate relief previously 10 granted by this Commission, the level of earnings of the Company remain 12 13 and its financial integrity is continuing to decline.In order to continue our"bare bones" construction program, it is absolutely essential 14 15 that our bond rating be restored by Moody's at the earliest possible moment.'11 significantly below what the Commission has previously determined fair and reasonable.
This means that CP6L is not recovering all of its costs 16 17 18 19 20 For the bond rating to be restored and maintained, it will be necessary that our coverage of fixed charges improve to a level of at least 2 1/2 times and be maintained there for an appreciable period of time.Without rate relief, we would expect the amount and quality of our earnings to decline dramatically, especially as new plant comes into service.Without rate 21 22 relief which we now request, our bond rating will be sub)ect to further/deterioration and drastic cuts will have to be made in what is already 23 24 25 26 a"bare bones" construction program.Beyond any question, unless we obtain the rate relief requested in this application, the Company's ability to continue to provide service efficiently to its customers will ultimately suffer.
South Carolina Public Service Commission CAROLINA POWER&LIGHT COMPANY DIRECT TESTIMONY OF EDWARD G.LILLY, JR.1'Q Please state your name and business address.2 A.Edward G.Lilly, Jr., 336 Fayetteville Street, Raleigh, Noith 3 Carolina.4 Q.What is your position with Carolina Power&Light Company?5 A.I am Senior Vice President-Finance of the Company.Q..Please describe your educational background and business 7 experience.
A.I am a graduate of Davidson College where I received a degree 9 of Bachelor of Science in Economics.
I hold a Master of 10 Business Administration degree in Banking and Finance from the Wharton School of Finance at the University of Pennsylvania.
12 13 I am a graduate of the Executive Program of the University of North Carolina and I have completed the Irving Trust Company 14 Public Utility Finance Seminar.I am a member of the Executive 15 Committee of the Edison Electric Institute Finance Committee.
16 17 18 From 1952 to 1971 I was associated with Wachovia Bank and Trust Company, where I held various positions which'were related principally to financial analysis, handling loans for corporate 19 customers and administration.
From 1963 to 1970 I served as 20 Senior Vice President and Office Executive of Wachovia's banks 21.in the Durham area.During 1970-1971 I served as Manager of the Investment Services Department at Wachovia's headquarters in Winston-Salem.
In March 1971, I became associated with Carolina 3 Power&Light Company as Senior Vice President-Finance.
4 Q.Please describe your duties as Senior Vice President-Finance of 5 Carolina Power&Light Company.A.I am the senior financial officer of the Company and as such I am 7 responsible for the long-term and short-term financing programs 8 of the Company.I have responsibility for planning and implement-ing the issuance, sale and servicing of first mortgage bonds, 10 preferred stock, common stock and any other securities issued by the Company, as well as short-term financing arrangements of the 12 13 Company including the negotiation of bank loans an'd commercial 4 paper.In addition, I am responsible for developing and maintain-14 15 16 17 18 19 20 21 22 ing the Company's investor relations program with the financial community.
I have overall responsibility for the treasury, accounting, computer services, purchasing and internal auditing functions of the Company, including preparation of budgets and forecasts and all financial statements issued by the Company.My responsibility also includes the management of Company funds to insure that the Company has available at all times sufficient cash to pay its expenses of operation and to meet its payments for con-struction work.Please state the nature and scope of the testimony which you will 24 offer.25 A.This testimony will relate to the Company's financing plans which 26 must be implemented in order to obtain the funds necessary to meet the tremendous challenge facing the Company of constructing sufficient generating and other necessary facilities to meet the needs of our customers and to the problems facing the Company in 4 the undertaking of this financing.
Q.Will you please explain the Company's financing plans?A.Despite the emphasis on energy conservation which has been stressed 7 by the Company for several years,'he electric energy demands of 8 our service area continue to grow to such an extent that the 9 Company's planned construction expenditures for the next 10'years 10 12 will amount to approximately
$6.3 billion.In the first quarter of this year, energy demand rose 13 percent over the same period last year.We anticipate that approximately
$4.0 billion of this 13 amount must be financed through the attraction of new capital to 14 the Company from the sale of securities in the financial market, 15 16 an amount unprecedented in the history of Carolina Power&Light Company.The impact of this program is brought into focus by 17 comparing the additional
$6.3 billion plant investment with the 18 Company's net plant account of$2.2 billion at year end 1975.19 Looking to the immediate future, the Company's construction expendi-20 21 22 tures for the years 1976 through 1978 are expected to amount to$826,000,000.
In order to finance this three-year construction program, the 23 Company must raise a substantial portion of the$826,000,000 by 24 25 the attraction of additional capital to the Company.These funds can be obtained only through the sale of the Company's securities 26 to willing investors in the open market.The Company now has
~1 about 91,000 shareholders.
Over 39,000 of them, or approximately 43%, are located in the Carolinas.
We cannot expect investors to continue to invest their savings in our Company unless we can earn'n adequate rate of return on such investment and provide satis-5 factory dividends.
6 Q.How does the Company plan to secure funds to meet its construction 7 program for the years 1976-19782 8 A.A portion of the required funds will come from retained earnings, 10 charges to depreciation and deferred income taxes.However, a major portion of the funds must be obtained by the sale of additional securities of the Company.We must sell new securities in sub-12 stantial amounts each year.13 14 15 16 17 A brief review of the securities offered to the public by th'Company during 1975 illustrates the cost penalties which must be borne by the Company and its customers as a result of an unsatis-factory financial condition.
During January 1975, it was necessary for the Company to sell 18 common stock in order to attract capital and to improve the common 19 20 21 22 23 equity ratio of the Company which had fallen to a low level of less than 30%.The Company sold 4,000,000 shares of common stock which resulted in a net'rice to the Company of only$14 per share, which was approximately 60%of the book value of the common stock at the time of the sale.Obviously, such a sale of common equity 24 25 is extremely unsatisfactory and substantially dilutes the value of the shares of common stock previously held by the Company's share-26 holders.
During March 1975, the Company would like to have sold preferred stock.However, because of the continued decline in earnings avail-able for interest and preferred dividends, the coverage ratio for interest'ayments and preferred stock dividends had been reduced to the level where the Company did not meet its required Charter test'to market preferred stock.Thus, it was necessary for the Company to sell preference stock, a junior security to preferred stock, in order to attract needed capital.Since the preference stock was basically 10 unattractive to institutional investors, it was necessary to offer the stock at a 925.00 issue price, as opposed to the$100.00 issue 12 14 price which had previously been used by the Company for distribution of preferred stock, thus substantially increasing the distribution cost.The net cost to the Company for the funds obtained through the sale of preference stock was 11.17%, the highest rate ever paid 15 by the Company on preferred or preference stock.16 During April 1975, the Company offered$100,000,000 of first'7 mortgage bonds.Since theCompany was utilizing the fund's to finance 18 generating and other long-life equipment installed for the benefit 19 20 21 22 of its customers, the Company wished to sell bonds with a maturity of 30 years.However, as a result of the bond rating of the Company having been reduced from A to Baa by Moody's Investors Service, because of the unsatisfactory earnings of the Company resulting in fixed charge coverage of less than 2.0 times, it was not possible 24 for the.underwriters to market 30-year bonds on any satisfactory 25 basis.Thus, the maturity of the bonds had to be reduced to nine 26 years and sold at a net cost to the Company of 11.24%.This cost was the highest cost the Company had ever experie'need in connec-tion with its f ir st mortgage bonds.During the fall of 1975, the common equity ratio of the Company was again at an extremely low level of less than 30%and thus it was necessary for the Company again to sell common stock in order to attract capital and improve the common equity, ratio.The Company 7 sold 5,000,000 shares of common stock during'October 1975 at a net 8 price to the Company of 917.215 per share or approximately 75%of 9'ook value.Again, this sale of common stock resulted in additional 10 12 13 14 15 substantial dilution to the present shareholders of the Company.During the years 1976-1978, the Company will need to sell sub-stantial additional amounts of securities.
The exact timing and types of securities sold will be influenced by the ability of the Company to meet coverage ratio tests and maintain a reasonable capital structure, as well as the conditions of the securities markets during 16 those years.One of the major problems facing the, Company is the 17 need for continued sales of large amounts of common stock, which the 18 Company needs to sell at prices above book value.19 Q.What, if any, other problems do you feel the Company faces in 20 carrying.out this financing program?21 A.Historically, the Company has raised capital for its construction 22 23 24 25 program through the sale of first mortgage bonds, preferred stock and common stock.Let me examine briefly the current situation relative to the Company's ability to issue such types of securities.
First Mort a e Bonds 26 Table I listed below shows the average cost of outstanding 3, bonds at the end of each of the past ten years and at June 30, 1975.As recently as December 31, 1969, the average cost of all bonds outstanding was 4.72%.This, average cost has increased with the sale of each issue of bonds by the Company and had reached 7.72%by year end 1975, an increase of 63%during the six-year period.TABLE I 8 Year End of Year Embedded Cost All Bonds 10 1966 4.04 1967 4.40 12 1968 4.72 13 1969 4.72 14 1970 5.64 15 1971 6.14 1972.6.40 17 1973 6.77 18 1974 7;29 19 1975 7.72 20 21 The ability of the Company to acquire capital through the sale of first mortgage bonds at a competitive interest rate is 22 principally determined by the rating which the first mortgage 23 bonds of the Company are assigned by the major bond rating 24 25 26 agencies.As a result of declining earnings and thus declining fixed charge coverage ratios, the first mortgage bonds of the Company were downrated during 1971 by both of the major rating 4 agencies from AA to A.Fixed charge coverage ratios declined further during 1973 and 1974 and by December 1974 had dropped to the dangerously low level of 1.92 times.Moody's reduced h the rating on the Company's first mortgage bonds to Baa, further aggravating the ability of the Company to raise needed capital.During the second half of 1975, principally as a result of the addition of revenues collected, subject to refund, under South Carolina and North Carolina interim rate increase orders and 10 a wholesale rate increase order from the Federal Power Commission, the Company's fixed charge coverage improved slightly to 2.27 times by year end 1975.However, we feel it absolutely necessary for the fixed charge coverage ratio to increase to a minimum of 2.5 times 13 and to remain somewhat above that level in order for the Company 14 to retain its A bond rating and to hold such a bond rating.Table II lists the year end fixed charge coverage ratios of 16 the Company, as calculated under the Securities 6 Exchange formula, 17.for the past 10 years.18 TABLE II.19 Year" Fixed Char e Covera e Ratio 20 1966 5.16 21 1967 4.87 22 1968 4.32 23 1969 3.38 24 1970.2.25 25 1971 2.50 26 1972 2.90, 27 1973 2.34 28 1974 1.92 29 1975 2.27 As shown, as recently as December'31, 1972, the fixed charge coverage ratio was 2.90 times, but had declined to 1.92 times as of December 31, 1974, a decline to a dangerously low level.While the collection of"subject to refund" revenues allowed under interim rate orders and the receipt of a rate order making permanent all revenues collected on North Carolina retail sales has resulted in an improvement in fixed charge coverage during recent months, as of the time of the preparation of this testimony, the Company still has not 10 received a restoration of its A bond rating from Moody's Investors Service.If the coverage of fixed charges does not continue to 11 improve in the near future, the Company risks not only a continuation 12 of the Baa rating assigned by Moody's, but a downgrading of the A 13 rating presently assigned by the other major bond rating agency.14 Q.What effect has the reduction of the rating on the Company's bonds 15 from A/A to Baa/A had upon the Companyf~A.T1ie reduction of the rating on the Company's first mortgage bonds 17 18 to Baa/A has had three major negative effects upon the Company.First, the reduction in rating requires that the Company pay a 19 20 21'2 23 24 25 26 substantially higher cost in order to sell its bonds.In his testimony, Mr.Shearon Harris has pointed out that in April 1975, after the downgrading of CP&L's bonds, the Company sold$100,000,000 first mortgage bonds at a cost to the Company of 11.24%.The next sale of a comparable size issue with a comparable maturity by an electric utility company with an A/A rating occurred a short time later when Florida Power&Light Company sold$100,000,000 of first mortgage bonds at a cost of 9.08%, 216 basis points lower than the cost CP&L was required to pay.While the difference in cost between a Baa/A bond and an A/A bond will vary, it is expected that the cost differential generally will be high.Since CP&L utilizes most of the funds obtained from the sale of first mortgage bonds to pay for assets with an expected life of 25 years or longer, it has been the practice of the Company to sell bonds with a maturity of 30 years.Unfortunately, the CP&L'I bond rating of Baa/A was not sufficiently high to attract investors to a 30-year maturity at the time of the'last bond sale and thus 10 12 13 14 15 16 it was necessary for the Company to sell bonds with a maturity of only nine years.Such action,'of course, indicates that the risk of additional financing and the expense of additional financing must be met during the expected life of the assets.Second, a reduction in bond rating has eliminated certain sources of funds to the Company;that is, many institutional investors and large individual investors as a matter of policy or of legal limita-17 tion will not purchase a bond with a rating below A/A.For example, 18 19 pension funds for the employees of the States of South Carolina and North Carolina may no longer be invested in bonds presently being 20 offered by CP&L.Such restrictions of the market in which the 21 bonds of the Company are sold increase greatly the difficulty of 22 23 marketing the Company's bonds at any reasonable interest rate.Third, the reduction from the A/A rating of the Company's bonds 25 26 also has had a substantial adverse impact upon other financing costs of the Company.At the time Hoody's reduced the Company's bond rating, it also reduced from A to Baa the rating on the Company's lo-preferred stock and reduced the rating on the Company's commercial paper from Prime 1 to Prime 2.The Prime 2 c'ommercial paper rating has resulted in the Company's cost for these short-term borrowings increasing by 50 to 75 basis points.(i.e., 6.00%to 6.50%or 6.75%).The rating assigned to a Company's first mortgage bonds is in effect the"key rating" to which other securities and borrowings
~of the Company are related.The fact that CP6L's securities are now rated below investment grade has had a substantial adverse impact 10 upon the cost of long-term and short-term securities'ssued by the Company, as well as any lease financing or other types of financing 12 which the Company may utilize.Preferred Stock 13 Q.Please comment upon the difficulty, if any, of selling preferred I 14 stock.15 A.Table III lists the average cost of preferred stock of the Company 16 at the end of each of the past 10 years.17 18 Year TABLE III Weighted 19 1966 4.72, 20 21 1967 1968 5.06 5.06 22 1969 5.06 23 1970 6.46 24 1971 6.91 1972 7.17 26 1973 7.24 27 1974 7.54 28 1975 8.06 Here again, it is noted that as recently as December 31, 1969, the average cost of preferred stock was 5.06%.As of December 31, 1975, this cost had increased to 8.06%, an increase of 59%.As was discussed earlier, during most of 1975, the Company, because of reduced earnings available to pay interest and preferred stock dividends, did not meet its Charter require-ments for the issuance of additional preferred stock.Thus, the Company simply was in a position where it could not issue preferred stock and had to resort to other, more expensive, sources of 10 capital.In March 1975 it was necessary for the Company to issue preference stock, a class of stock rated junior to preferred stock,-.12 13 14 15 16 17 18 at a cost to the Company of 11.17%.The cost of issuing preferred or preference stocks with ratings.lower than A/A was quite high during 1975.For example, during September 1975, Indiana Michigan Electric Company sold an issue of preferred stock with a rating of Baa/BBB at a cost to the Company of 12.75%.It is noted that the rating obtained by Indiana Michigan Electric Company was above the'I rating which could have been obtained on CP&L reference stock.19 20 Since preference stock is a junior issue to referred stock, the rating agencies normally assign a rating to preference stock one 21 rating below the rating assigned to preferred stock.22 Again, the collection of additional revenues, which are subject 23 to refund as aLlowed by interim rate increases, has allowed the Company's earnings to improve sufficiently to meet the Company's 25 26 Charter requirements for'he issuance of preferred stock provided such revenues are made permanent by the appropriate regulatory 27 authorities.
12-Common Stock 2, Q.Please comment upon the common equity ratio of the Company.3 A.It is vitally important that the Company, be able to sell common stock successfully.
Common stock is the foundation upon which senior capital financing rests..The bond holder-and other senior capital holders look to an adequate common stock equity base for protection of"their investments.
Thus, the common equity ratio of the Company is extremely important in determining the Company's continued ability to sell senior securities.
The goal of the 10 Company is a common equity ratio of approximately 35%.The long-term financing plans of the Company are designed to achieve this 12 goal.However, after the sale of two issues of common stock 13 totaling 9,000,000 shares during 1975, the common equity ratio of the Company is less than 33%and thus the Company will need to sell 15 16 additional common equity in the near future.While general financial market conditions have improved and the market price of CP&L common 17 stock has also improved, the stock of the Company still has a 18 market price below book value.19 Q.Does the Company experience any significant difficulties in attract-20 ing common equity?21 A.During 1965, the common stock of CP&L sold at$52 per share.During 22 23 24.25 late 1974, the common stock of the Company sold below$11 per share or at less than 50%of book value.Table IV shows the relationship of the sales price of common stock to the book value per share for the last four sales of common equity by the Company.
Date of Sale TABLE IV Number of Shares Net Price Per Share Book Value Percentage
~Above or Below Book Value ll/9/72 2,500,000 11/15/73 30000,000 1/16/75 4,000,000 28.05 20.31 14.00 21.16 23.25 ,.23.35 32.6 (12.6)(40.0)17.215.10/28/75 5,000,000 (25.6)The rapid and sharp reduction from the ability to sell common 10 12 13 14 equity at more than book value to the necessity to sell at prices substantially under book value is having a severe impact upon the ability of the Company to attract common equity on any reasonable.basis.When the stock of a company is selling below book value, a greater number of shares is required to be issued in order to obtain 15 a given amount of equity capital.This action results in additional 16 dilution in the existing shareholder's equity and a dilution in his 17 18 future earnings per share.Such action further depresses the market price of the existing stock, thereby increasing the cost of equity 19 and debt financing to the Company and making it'even more difficult 20 for a company to finance on any reasonable basis.21 Q.Are there other factors which add to the difficulty which the Company 22 experiences in raising the funds necessary to meet its construction 25 26 result from allowance for funds serious adverse impact upon the 23 responsibilities?
24 A.Yes, the substantial percentage of earnings of the Company.which used during construction has had a securities of the Company in the financial markets.Table V lists the amount and percentage of net income available for common stock that is composed of allowance for funds used during construction for the years ended December 31, 1969 through December 31, 1975.7 12 Months Ended TABLE V Allowance For Funds Net Income Allowance For Used During Construction After Preferred Funds Used During As%of Net Income*"'ecember 1969 24,418,000 4,397,000 18.0 20,126,000 10,505,000 9 December 1970 10.December 1971 29,103,000 14,708,000 24,759,000, 38,093,000 52,982,000 12 December 1973 13 December 1974 14 December 1975 51,599,000 54,609,000 59,957,000 75,870,000 December 1972 50,917,000 52.2 50.5 48.6 71.9 105.8 79.0 15 Q.Please explain the changes in this percentage and the significance 16 of these changes to the Company.A.During the year 1969, only 18%of the net income available for common 18 stock was a result of allowance for funds used during construction.
19 20 21 This percentage increased rapidly to a level of approximately 50%during the period 1970 through 1972.During the years 1973 through 1975, the percentage again increased sharply averaging approximately 85%during the most recent three years.It is noted that during the year 1974, allowance for funds used during construction actually 24 exceeded net.income available for common stock.Regardless of the 25 current accounting treatment of allowance for funds used during 26 construction as"nonoperating income," the amounts are not revenues-15 received from the sale of electricity.
When allowance for funds used during construction is excluded from the calculation for fixed charge coverages, the ratio for the year ended December 1975 drops from 2.27 times to an alarming level of 1.67 times.10 This situation results from the large amount of construction work in progress upon which the Company realizes no cash earnings.On average during 1975, construction work inprogress amounted to$886,000,000 or approximately 75%of net plant in service.Thus, for every dollar of net investment of plant in service, the Company had approximately 75C invested in construction work in progress upon which it did not receive any cash earnings.Mitchell, 12 Hutchins, inc., a highly regarded research firm in the financial 13 14 community, conducted a study of 45 major electric utility companies during April 1975.This study shows CP&L as the only company where 15 allowance for funds exceeded net income for common stock during the'16 17 year 1974.Such a condition obviously causes grave concern in the minds of investors as to the financial soundness of a company.1 18 g.Mr.Lilly, please summarize the factors,to which you have testified 19 which cause difficulty in attracting capital to meet the Company's 20 construction expenditures.
21 A.~e financial condition of the Company deteriorated rapidly during 22 23 24 25 26 1974 and 1975.Fixed charge coverage fell to extremely low levels.resulting in a reduction in the ratings of the Company's first mortgage bonds, preferred stock and commercial paper.The percentage of net income available for common stock represented by allowance for funds used during construction h'as increased rapidly and during 1974 allowance for funds used during construction actually exceeded total,net income available for common stock.The cost of attracting capital to the Company has continued'to increase and remains at a high level.These factors, when combined with a return on common equity of an amount less than the earnings level which this Commission has previously found to be fair and reasonable, have resulted in the necessity of the Company selling additional common stock at prices below book value.The selling of common stock below book'value further aggravates the serious financial condition of the Company.Without the interim rate increases ordered by this Commission and other regulatory jurisdictions, the Company's financial condition continues to be critical.The approval of the requested rates so as to allow the Company to restore its coverage of fixed charges and preferred dividends and to earn a reasonable return on equity capital is absolutely essential in order for the Company to continue to finance its operations and to provide adequate and dependable service to its customers'7-South Carolina Public Service Commission Docket Nos.18,361 and 18,387 CAROLINA POWER&LIGHT COMPANY TESTIMONY OF PAUL S.BRADSHAW 1 Q.Please state your name and business address.2 A.Paul S.Bradshaw, 336 Fayetteville Street, Raleigh, North Carolina.3 Q.What is your occupation?
4 A.Assistant'Treasurer in charge of the Budgets and Statistics Section 5 of the Treasury and Accounting Department of Carolina Power&Light 6 Company.7 Q.Please describe your educational background and business experience.
8 A.I attended Southeastern University and graduated from the Accounting 9 School'of that University with a Master's Degree in Accounting.
10 Immediately prior to joining Carolina Power&Light Company in July, 11 1962, I worked for the Washington Gas Light Company, a natural gas 12 utility, in Washington, D.C.I.am a member of the Finance Section 13 of the Southeastern Electric Exchange and also a member of the 14 Budgeting Committee of the Edison Electr'ic Institute.
I have completed 15 the Public Utility Executive course at the Georgia Institute of 16 Technology.
17 Q.What are your duties with Carolina Power&Light Company?18 A.I have been responsible for the operation of the Budgets and Statistics 19 Section since its formation in 1972.I am responsible for the 20 Budget Unit, Statistical Unit and Financial Analysis.Prior to 21 formation of the Budgets and Statistics Section, I was Assistant 22 Controller in charge of General Accounting.
23 Q.Please examine this document, marked"Bradshaw Exhibit No.1," 24 consistingof twelvepages, and state whether or not it was prepared 25 under your supervision and direction.
1 A.Yes, it was.(Identify) 2 Q.Will you describe this exhib5.t?3 A.This exhibit sets out, the balance sheet of the Company as of 4 December 31, 1975, and statements of income and retained earnings 5 of the Company for the twelve months which ended December 31, 1975.-'It contains notes which are an integral part of the statements.
7 This exhibit'is the same as Exhibit I filed with the Commission 8 in.the series of exhibits containing data for the test period 9, consisting of the calendar year 1975.10 Q.Will you please examine this document, marked"Bradshaw Exhibit No.2," and state whether or not it was prepared under your supervision and 12 direction7 13 A: Yes, it was.(Identify) 14 Q.Please describe this exhibit.15 A.This exhibit sets forth the original cost of the electric utility 16 17 plant in service of our Company as shown on our books and records at December 31, 1975.After deducting$18,507,102, representing 18 the accumulated provision for amortization of nuclear fuel, the 19 total amount of plant in service and nuclear fuel is$1,888,955,553.
20 The plant in service is subdivided into functional accounts.Of 21 22 23 course, the nuclear fuel is related only to the production function.This exhibit is the same as Exhibit C in the exhibits filed with the Commission.
24 Q.Will you please examine this document, marked"Bradshaw Exhibit No.3," 25 26 and state whether or not it was prepared under your supervision and direction, and state what is shown on this exhibit2 I A.Bradshaw Exhibit No.3," which is the same as Exhibit D filed for the test period 1975, was prepared under my supervision and direction and states the amounts of the accumulated provision for depreciation of plant in service as shown on the books at'ecember 31, 1975.The amounts have been adjusted to reflect depreciation for a full year on plant in service at that date.7 The amounts are shown by functional accounts corresponding to 8 the functional accounts under plant in service on my Exhibit No.2.9 Q.Will you please state whether or not Bradshaw Exhibit No.4 was 10 prepared by you or under your supervision?
L ll A.Yes, it was.(Identify) 12 Q.Will you please describe this exhibit?13 A.This exhibit shows the Company's operating revenues and operating 14 expenses by major categories for the calendar year 1975.15 Q.Have you made any accounting and proforma adjustments to the test 16 year?17 A.Yes.The adjustments made to the test year are summarized in 18 Bradshaw Exhibit No.5.19 Q.Would you please explain these adjustments?
20 A.Yes.Adjustment No.1 was necessary to correct insurance expense 21 for the test year.Insurance expense applicable to the Brunswick 22 23 No.2 unit in November and December 1975 was inadvertently charged to plant account and should have been charged to expense.This 24 25 26 adjustment charges expense in the amount of$109,024.Adjustment No.2 is necessary'to charge-off one-fifth of the cost of abandoning the Craven County Plant site.The five-year write-off was ordered by this Commission.
Il Adjustment No.3 is to normalize the effect of hydro generation for the test year.The value of hydro generation in the test year was adjusted to the 45-year average hydro generation resulting in a charge to Expense of$1, 168, 558.Adjustment No.4 is to reflect wages for the test year based on the year-end level.This requires an increase in operating expenses of$4,560,087 and a related increase in payroll taxes of$234,822.10 Adjustment No.5 is necessary to reflect in the test year the 12 13 effect of a postage increase that was placed in effect December 28, 1975.The effect on operating expenses would be an increase of$293,331.Adjustment Nos.6, 7 and 8 are to increase maintenance expense 15 for the test year to a more normal level.During 1975, because of 16.low earnings and coverage, the Company was operating under a program 17 of reduced expenses in all areas possible.The expenses'hat were deferred or eliminated in 1975 must be resumed in the future.During a normal operating year, additional maintenance expenses in 20 21 the amount of$5,217,000 would be required.The amount deferred in each category was production
-$507,000;transmission
-$710,000;22 23 24 and, distribution
-$4,000,000.
Adjustment No.9.was made to adjust depreciation expense to the level of plant in service at year-end and also to compensate 25 26 for a change in depreciation rates.The change in depreciation rates is the result of a study made by Ebasco Services, Incorporated, and will be testified to in this case by Mr.Reilly.Adjustment No.10 is necessary to compensate for an increase in Social Security taxes.The PICA taxable wage base was increased from$14,100 to$15,300 thus necessitating an increase'o the test year tax expense of$57,508.Adjustment No.11 relates the property taxes to the yearŽend level of Plant in Service at the end of the test year.To adjust the property tax expense to the year-end level of Plant, in Service required an increase in pioperty tax expense of 10$4,091,032.
12 Adjustment No.12 is necessary to achieve comprehensive interperiod allocation of income taxes.The adjustment in the amount of$15,614,000 to deferred taxes in the test year accomplishes full normalization of deferred taxes.15 Q.Will you state whether or not the Company maintains bank balances 16 as a part of its commitment in connection with loans obtained 17 from banking institutions.
18 A.Yes.19 Q.What was the amount of such bank balances supporting loan 20 commitments at December 31, 1975.21 A.The amount of such balances then was$9,350,000.
These funds 22 are not maintained to support normal bank accounting services 23 24 such'as checking and collection of funds deposited, but are specifically required in connection with credit extension.
25 Q.Is the Company requesting any change in its treatment of deferred 26 fuel cost in this proceeding?
1 A.Yes, it is.The Company has been deferring the expensing of 2 increased fuel costs on its books until the month in which 3 related revenues are billed.However, beginning with the effective date of the new fuel clause proposed in this 10 proceeding, we will no longer use deferral accounting for fuel expenses.At that time all fuel costs will be expensed on a current basis.When the new fuel clause goes into effect the books of the Company will contain two months'dditional fuel cost that must be collected from the customers.
This is fuel costs for the prior two months in excess of the base cost.This fuel has been used in serving the customers 12 13 and must.be paid for by the customers.
Without collecting revenues to cover these deferred fuel costs, the Company will be 14 unfairly penalized and earnings will be adversely affected.15 Q..How do you propose to collect this deferred fuel expense from the 16 customers?
17 A.We propose to collect the deferred fuel expense by a temporary 18 19 20 21 22 23 24 charge on the customer's bill for a period of approximately 12 months.The amount of the temporary charge will be determined by the amount of deferred fuel expense attributed to South Carolina retail sales at the time the new rates are placed in effect.This amount could be collected in a shorter time period, but we believe 12 months is a fair and reasonable time period.Assuming the new rates are placed in effect September 1, 1976, the charge will be.072 cents per 15lH based on the fuel cost deferred in July and August.This will be billed on Temporary Rider No.40, which is attached as Bradshaw Exhibit No.6.A copy of this Rider is also included in the Exhibit which presents the alternate rates that the Company is.requesting in this proceeding.
South Carolina Public Service Commission CAROLINA POWER&LIGHT COMPANY TESTIMONY OF JOHN J.REILLY 1 Q.Will you state your name and address?2 A.My name is John J.Reilly, and my place of residence is Glen Cove, Long Island, a suburb of New York City.4 Q.What is your occupation, Mr.Reilly?5 A.I am a professional engineer employed by Ebasco Services Incorporated at 100 Church Street, New York City, and hold the position of Consulting Engineer.8 Q.9 A.What kind of organization is Ebasco Services?Ebasco has provided engineering, design, construction and 10 12 13 management consulting services to public utilities, other industries and governments for the past 70 years.It is one of the foremost designers and constructors of power plants in the world.14 Q.Will you summarize briefly your education and professional 15 experience?
16 A., I am a graduate of Ohio University with a degree of Bachelor 17 18 19 20 21 22 of Science in Civil Engineering in the year 1932.I also completed graduate courses in Power Plant Engineering at Columbia University during 1939 and 1940.During the period 1933-1937, I worked for the City of New York as Structural Design Engineer.I was employed by Ebasco Services Incorporated as a Design Engineer in April.1937.Since 1937, except for a two-year period of service in'the Navy, I have been continuously employed by Ebasco.During the ma)or part of the 37-year period I have been engaged in engineering work closely related to the appraisal of industrial property.These appraisal studies were made generally for acquisition sale, financing, rate condemnation and tax purposes, or to satisfy the requirements of local, State and Federal regulatory agencies.During this 37-year period, I assisted with appraisal studies for some 200 industrial and 10 12 government clients, more than half of which were public utility clients.During this same period I either made or directed approximately 125 depreciation studies for some 55 public utility clients.In connection with these appraisal or depreciation
.13 studies, I participated in conferences, or hearings, as a'4 15 consultant, or expert witness, in proceedings before the following regulatory agencies: 16 17 18 19 20 21 22 23 Florida, Idaho, Indiana, Kansas, Massachusetts, Nevada, New Mexico, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, South Carolina, Virginia, Washington, State Public Utilities Commission, Federal Maritime Commission, Federal Power Commission, Department of Justice and Internal Revenue Service.24 I have also appeared as an expert valuation and depreciation 25 witness before Courts of law in the United States and Canada.26 Q.I-show'you a document consisting of seven pages entitled Depre-27 ciation Studies involving Statistical Methods Made for Public 28 Utility Clients and ask you if that is a list of public utility 29 clients for whom you have made depreciation studies?
1 A.Yes it is.2 Q.Are you a Licensed Professional Engineer?3 A.Yes, I am a registered Professional Engineer in the states of 4 Indiana, Louisiana, New York, Pennsylvania, Rhode Island, Virginia, Texas, and Washington..I also hold a certificate of qualification issued by the National Bureau of Engineering Registration.
8 Q.Are you a member of any professional societies?
9 A.Yes, I am a member of the American Society of Appraisers and 10 the American Society of Civil Engineers and formerly a member 11 of the Depreciation Accounting Committee of the Edison Electric 12 Institute from 1949 to 1973.13 Q.Was Ebasco employed by Carolina Power&Light Company to make a 14 depreciation study in preparation for this case?15 A.Ebasco was given an assignment to make a depreciation'tudy of 16 the Company's electric plant in service at December 31, 1974.17 Q.How long has Ebasco been making depreciation studies for CP&L?18 A.Ebasco has been making depreciation studies periodically for the 19 20 21 22 23 24 25 26 Company since 1950, when it adopted straight-line depreciation accounting to meet the requirements of the uniform system of accounts of the North Carolina, South Carolina and Federal Power Commissions.
These depreciation studies were made by Ebasco every five years since 1950.As a result of each study, Ebasco recommended annual depreciation rates for all functional classifi-cations of property and the Company generally adopted our recommendations for depreciation accounting purposes.
1 Q.Were these depreciation studies made by you or under your direction?
3 A.Yes.4 Q.I hand you this exhibit entitled,"Carolina Power&Light Company-Depreciation Study of Electric Plant in Service at December 31, 1974", and ask if it was prepared'under your supervision and direction?
8 A.Yes, it was.(Identify as Reilly Exhibit No.2.)9 Q.Please explain this exhibit.10 A.Reilly Exhibit No.2 is the latest of the periodic depreciation 12 14 15 studies which I have mentioned above.It contains the results of our current investigation of average service lives, salvage and cost of removal for the various classes of property which the Company owns and the theoretical depreciation reserve requirement at December 31, 1974, based on the assumption that 16 17 these average service lives and net salvage had been used to compute the annual depreciation expense.during the expired life 18 of the property as of that date.We propose to amortize the 19 difference between the theoretical depreciation reserve, so 20 21 22 23 computed, and the book reserve over the estimated remaining life of each class of property at December 31, 1974.This procedure, which has been recommended by the National Association of Rail-road and Utilities Commissioners, results in the inclusion of 24$1,354,000 per annum as part of the annual depreciation expense.
The-annual depreciation rates which we'recommend for the year 1975, as shown in Schedule l of Reilly Exhibit No.2, contain the provision for this amortization.
4 Q.Mr.Reilly, what are the bases for the lives, curve types and 5 net salvage rates you have selected for the various plant 6 accounts?7 A.Generally the average service lives, Iowa Curve types and net 10 ,salvage selected for each account are based on my judgment after giving consideration to our analysis of available past retirement experience as determined from CP&L property account-ll ing records;present and anticipated future system requirements 12 of CP&L;and industry-wide experience and trends relating to 13 future life expectancy of various classes of property.14 Q.Mr.Reilly, can you be more specific by explaining to us the 15 approaches you used for each of the functional.classes of 16 property?17 A.Yes, I can.First, we looked at the production plant function 18 and segregated it into two separate groups.One contained the 19 production plants comprising the fueled type of generation and 20 included nuclear, fossil fueled steam plants and gas turbine 21 22 units, while the other contained the Hydraulic Production, Plants.The decision to approach steam, nuclear, and gas turbines23 generation facilities as functional groups stems from the fact 24 that upon retirement of a generating unit, all associated components are no longer useful.Modern plant structures are also of little, if any, use for other purposes.Massive out-lays of capital for large plants together with little retire-ment experience
'for comparable plant limit the use of actuarial studies.For the fueled generating plants, there was little Company experience with regard to past retirements 10 12 and there occurred many new and important events since my last study which, in my opinion, would have a greater effect on my selection of lives of these production facilities than past-retirement experience considered alone.There were basically three events which can be classified in two categories:
(1)environmental and (2)fuel, that occurred since 1970 which 13 have had drastic economic effect on this functional category.14 Mr.Reilly, will you please explain the events which occurred 15 in the environmental category to which you gave consideration?
16 A.Yes, I will.Prior to the late 1960's, there was little acknow-17 18 19 20 21 22 23 24 ledgement on the part of the government or by the public as to the pollution of the environment by our industrialization.
Some electric utilities were keenly aware of it and included precipi-tators in all their coal-fired power plants.Other electric utilities, primarily those in larger urban areas, installed precipitators only in their newer larger plants, while some electric companies installed none at all.'he action which brought the problem of pollution into focus and to the attention of the public and industry, under the pressure of concerned groups, began in 1970 with the enactment of the"Clean Air Act of 1970", which required that the Administrator of the'5 Environmental Protection Agency (EPA)promulgate national primary and secondary ambient air quality standards.
This e act further required each state, within nine months after lf publication, to submit a plan for the implementation, main-tenance, and enforcement of the standards:
10"...as expeditiously as practicable but...in no case later than three years from the approval of such plant"-for the primary standards.
It also required 12 the implementation of the secondary standards in-13"...a reasonable time." 14 Two years later, the"Federal Water Pollution Control 15 16 Act of 1972" was passed.This act, aimed at eliminating polluting discharges into navigable waters by 1985, requires 17 19 20 21 that industries must have the most practicable cleanup equipment installed by 1977, and absolutely the best techno-logical equipment working by 1983-regardless of cost.Chemical limitations will become effective in 1977, with additional controls in 1983, and thermal limitations are to 22 23 become effective July 1, 1981, with possible deferral of compliance to July 1, 1983, if a system's reliability would 24 be seriously affected.
1 Q.Mr.Reilly, turning to the fuel category, will you please explain 2the events that occurred and which you considered in arriving at'your decision?4 A.Yes, I will.Subsequent to the promulgation of the acts I just 5 cited, the fuel oil crisis of 1973, which continues unabated, has 6 further aggrevated the conditions and affected the economics of 10 12 13 14 15 16 17 electric energy generation.
The fuel oil situation in 1973 and 1974 has further aggrevated and complicated the conditions under which electric utilities operate.Fuel costs have risen and probably will continue to rise to new and higher levels.Even competitive fuels, coal and nuclear, will rise as the demands for these increase with the trend away from oil.The scarcity of natural gas will probably limit its use in the generation of electricity.
Most recently, the stated goal for this nation to become energy independent will result in the search for oil and gas in'emote and inaccessible areas, e.g., the Alaskan slope, from which transportation costs will be a significant factor.The search 18 and development costs for other exotic energy conversion methods 20 21 and attendant facility costs, such as coal gasification, in this/high capital construction and financing era do not presage a quick k and inexpensive solution.22 Q.What has been the effect of these events as they relate to the 23.24 determination of average service lives and annual depreciation rates for fueled production plant?
1 A.As a result of these events, the=entire fossil fuel generation function is in a state of flux due to the requirements for air/quality control, cooling water pollution control and the effects of the fuel crisis.Any monies expended on old plants 10 to meet environmental protection requirements must be recovered over the remaining life of the facility.(Fuel costs have risen and will continue to rise, forcing difficult decisions, as to the continued use of an old, less efficient plant.)The economics of increasing fuel costs tied to additional substantial outlays of capital for air quality and/or water pollution control may well limit the life of old plants.We, therefore, deem it 12 13 advisable to lower the service life of existing steam generating facilities notonly in order to recoup the capital spent on 14 15 16 environmental protection equipment but also due to a distinct possibility of early retirement for economic reasons.Therefore, 3 we have recommended the lives and depreciation rates shown in 17 Schedule II of my Exhibit No.2 for steam, nuclear, and other 18 production plant accounts.19 Further, if the expected amount of capital required for SO 20 removal in the future is actually spent to make older plants meet 21 environmental requirements, then the annual depreciation rate as 22 recommended in this report could be inadequate.
23 g.Mr.Reilly, will you summarize the effects of your consideration 24 of these events?
1 A.Yes.For Steam Production Plants, all of the aforementioned were taken under consideration in our recommendation to increase the normal depreciation rate for those steam gene-rating facilities we have classified as"Other Steam Production Plant" from the current 2.468 percent to 2.947 percent.New steam plants of large size will be subject to even more stringent air and water control equipment than older plants.While the expected life of production plant equipment itself may not be changed significantly, the 10 12 13 14 15 16 17 18 19 20 22 23 associated environmental equipment may require replacement 1 or 2 times over the plant's lifetime.Little historical knowledge is available for plants operating at high temperatures.
It would be appropriate to expect a higher level of retirement and replacement of plant components subject to the higher temperatures and steam pressures to result.It is our opinion that new steam production plants represented by Roxboro Nos.1, 2 and 3, Asheville No.2, and Sutton No.3, plus any new plants coming into service should have a normal depreciation rate of 3.452 percent, which is 0.595 percent higher than the 2.857 percent recommended in 1969.The rates for both old and newer steam production include an allowance of 5 percent net cost of removal (negative net salvage for Account 311-Structures and Improvements and Account 312-Boiler Plant Equipment.
The Iowa Type Curve 24 applicable to the steam plants was selected by judgment.
With regard to Nuclear Production Plant, at the time of our previous study the Company did not have any Nuclear Production Plants in service.No statistical data are avail-able to make a historical analysis to determine the average life applicable to this relatively new type of plant, either on a Company basis or on an industry-wide basis.Therefore, by judgment we have selected a depreciation rate of 4.225 10 12 13 15 16 17 18'9 20 percent.This is based on a 25-year average service life for all components, together with a negative 10 percent salvage factor for Accounts 321-Structures and Improvements, and 322-Reactor Plant Equipment.
With regard to Other Production Plant, the Company's historical data are insufficient to apply statistical techni-ques to determine the average life of the gas turbines and related equipment included in Other Production Plant.The Company is currently using a 30-year average life.Due to the critical fuel supply for oil-or gas-fired turbine peaking plants, it is our opinion that the shortening to a 25-year average life is reasonable at this time.Since we have estimated zero percent net salvage, the recommended annual 21 depreciation rate is 4.000 percent.22 Turning to the balance of the production function, Hydraulic 23 Production, the depreciation rates I recommended in my Exhibit 24 No.2 are based on the composite of the average lives assigned to each of the major components comprising the account.The annual depreciation rate for each primary account for each plant is based on the composite of theaverage lives assigned to each of the major components comprising the account as of December 31, 1948, in the Ebasco study as of that date.Certain changes were made to the original average lives as assigned in 1948.The lives shown of the detailed sheets reflect the changes and support the annual rates used.10 The rates for, the Walters Plant were originally used in our previous report entitled,"Carolina Power&Light Company-12 13 14 Walters Project No.432-Actual Legitimate Original Cost and Accrued Depreciation (Recalculated with 150 year Ceiling Life)-Summary of Reserve Balances Years 1930 to 1956 Inclusive", which was submitted and accepted by the Federal Power Commission.
15 The Blewett Falls and Tillery rates were used in our report 16 17 18"Carolina Power&Light Company-Blewett Falls and-Tillery Hydroelectric Developments Projects No.2206-Summary of Recommended Depreciation Rates and Reserve Balances'Years 1912 19 to May 1, 1950, Inclusive-(Dated)November 1961-Revised 20 21 January, 1962.These rates were accepted by the Federal Power Commission.
The determination of rates for the Marshall hydro-22 electric plant-Project No.2380-follows the same method that 23 was applied to the other licensed projects.-12'-
Q.Mr.Reilly, now that you have explained the basis for your determination of lives for production function, will you 3 please continue with your explanation of how you selected 4 the lives and depreciation rates for the other functional' groups?6 A.Yes, l will.As I indicated in Exhibit No.2, in general, 10 the investigation of the service lives and mortality characteristics of the property in each account, other than production, plant, involved the following steps: 1)An analysis of available past retirement experience I from Company's acco'unting records, and 2)the modification 12 of the results of the analysis of such past retirement 13 experience to reflect judgment as to (a)present and antici-14 pated future system requirements and (b)industry-wide 15 experience and trends relating to future life expectancy of 16 various classes of utility property.The Actuarial Method 17 18 of life analysis using dollar units was employed in compiling mortality statistics.
Data through December 31, 1973, was 19 analyzed.20 The periods of years selected to provide experience data 21 for the life studies involving the methods l will discuss 22 23 shortly, was limited by the following considerations:
1)Primary accounting data must be on a consistent basis 25 26 2)Experience used must be fairly indicative of what might reasonably be expected in the future 3)Availability of useful data 1 Q.Mr.Reilly, earlier you mentioned"curve types" and"net 2 salvage".Can you explain these terms and how you arrived 3 at these factors?4 A.Yes.The actuarial method used to determine average service 5 lives for the various types of property also yields informa-10 tion as to the dispersion of retirements about that average age.In our study, we matched these dispersions with those, of the well known and frequently
'used Iowa Curves.Net Salvage is the difference between the cost of removal and salvage value received fram property retired.The net salvage percentages used in this report are expressed as a 12 percent of original cost.13 Q.Mr., Reilly, at this time will you explain the actuarial studies 14 you made?15 A.Yes.The Actuarial Method of life analysis using dollar units 16 17 18 19 was employed in compiling mortality statistics for all accounts other than the production plant.Data through December 31, 1973 was analyzed.This method of analyzing past experience represents the application to industrial property of statistical 20 procedures developed in the life insurance field for investigating 21 22 23 24 human mortality.
It is distinguished from other methods of life estimation by the requirement that it is necessary to know the age of the property at the time of its retirement and.the ages'f survivors, or plant remaining in service;that is, the installation date must be known for each particular retirement and for each particular survivor.The application of this method to the Company's experience involved the statistical procedure known as the"annual rate method" of analysis.This procedure relates the survivors of a given age in an account to the survivors of the previous age-year, thus yielding a sequence of annual survival probabilities*
from which a survivorship characteristic can be constructed.
Similarly the ratio of retirements of each age.-year to the survivors of the previous age-year may be used to get a series of mortality 10 13 14 probabilities which may be converted into a survivorship characteristic.
The mathematical combination of these two factors results in a series of relationships which, if plotted on graph paper, form what is known as a survivor,'r mortality curve.The length of this curve depends primarily upon the 15 years of experience available; so that, if the experience band 16 of years is short in relation to the average life of the property, 17 an incomplete or stub survivor curve results.There are a number 18.of acceptable methods of smoothing and extending this stub 19 survivor curve in order to compute the area under it from which.20 21 the average life is determined.
The well-known Iowa Type Curve Method was used in this study.In 1935, the Iowa Engineering 22 23~24 Experiment Station of Iowa State College published Bulletin 125 entitled,"Statistical Analyses of Industrial Property Retire-ments" by Robley Winfrey.This bulletin describes the development of 18 type mortality curves and their applicability to'industrial property having.a wide range of mortality characteristics.
Since their publication in 1935, these.type curves have been frequently used by public utility operating companies for depreciation accounting, tax, rate and other purposes.They have also found general acceptance with the Securities and Exchange Commission', the Federal Power Commission, the Bureau of Internal Revenue and many state public utility'commissions.
10 Q.Please continue with your explanation of your actuarial studies ll of life analysis.12 A.In the mortality study of the Company's property, instead of 14 15 16 17 18 mathematically smoothing and pro)ecting the stub survivor curve to determine the average life of the group, it was assumed that the stub curve would have the same mortality characteristics as the type curve selected.The selection of the appropriate type curve and average life was accomplished by plotting the stub curve on transparent graph paper and superimposing it on Iowa 19 curves of the various types and average, lives drawn to the same 20 21 scale, and then determining by judgment which Iowa curve type best suited the stub.In some accounts when this method was 22 23 used, average lives different from those indicated by the stub curve were selected on the basis of judgment.Such judgment 24 25 took into a consideration factors which indicated that the Company's past experience was not a reasonable criterion of 26 future life expectancy for the facilities now in service in those 27 par t'icular accounts.
1 Q.What was the basis of your determination of net salvage rates?2 A.The net salvage percentages used in this report are expressed 3 as a percent of original cost and were based primarily on judgments However, in determining this judgment, considerable weightwas given to the results of an analysis of the Company's experience with respect to salvage and removal costs for the 10 period of years 1969-1973, inclusive.
The net salvage ratios shown on Column V in the summary in Schedule IX of this exhibit may be explained as follows: 1.Where the ratio is shown as unity (1.00), it was assumed that the net salvage in that particular
'2 account would be zero.13 2.Where the ratio was less than unity, it was assumed 14 that the salvage exceeded the demolition costs.For example, where the net salvage was 20 percent, 16 17 18 19 the net salvage ratio was expressed as.80.I'.Where the ratio was greater than unity, it was,'ssumed that the demolition costs exceeded the salvage.For example, where the net salvage was 20 minus 5 percent, the net salvage ratio was expressed 21 as 1.05.22 These net salvage ratios were used in computing the annual 23 depreciation rate for each primary account in order that the 24 ,'ate could be applied to the gross balance in the account when calculating the annual depreciation accrual.For example, if the average life for an account were 50 years, the annual depreciation rate with zero net salvage would be 2.0 percent.However;if the>et salvage ratio were.90, the annual depre-ciation rate adjusted for net salvage would be the product of'the two, of 1.800 percent.I 7 Q.Where in your Exhibit No.2're the results of your mortality 8 study summarized?
9 A.Schedule II summarizes the results of my mortality study.In 10 Column IV under the heading Average Life and Iowa type curve selected, the letters.R, S, and L, together with the numerical 12 suffix, which accompanies them, represent the Iowa, type curve 14 15 16 17 18 selected for each account.The number prefixed to the letter is the average life in years, which together with the net salvage ratio shown in Column V determines the annual depreci-ation rate shown in Column VI of the Summary.Column VII represents the application of the rate in Column VI to the Original Cost at December 31, 1974, for each primary plant account, is used to determine the annual depreciation rate 20 applicable to each of the functional groups.21 Q.Mr.Reilly, will you please describe Schedule III of your Exhibit 22 No.2?23 A.Yes.Schedule III is a comparison of the estimated Reserve 24 Requirement at December 31, 1974, based on the average service 1'ives, curve types and net salvage selected for each primary 2 plant account, with the book Reserve for Depreciation.
The 3 comparison indicates a difference of$34,536,000.
4 Q.Mr.Reilly, can you explain the reasons for this difference?
5 A.Yes.The largest part of, the difference between the calcu-lated reserve and the book reserve at December 31, 1974, is'due to the change in average life and net salvage percent selected for Steam Production Plant.This change has been t caused primarily by the environmental requirements imposed on 10 this type of plant as well as the fuel situation, both of 12 13 15 16 17-18 19 20 which I discussed in detail and occurred since our 1969 depre-ciation study.Schedule III in this Section shows that of'the$34,536,000 difference between the calculated reserve and the book reserve,$23,005,000 is in the Steam Production Plant.The difference in Transmission Plant and Distribution Plant is caused mostly by the inclusion of'Rights of Way accounts in depreciable plant for depreciation accounting purposes only after 1968, when the Internal Revenue Service allowed the recovery of such costs through a depreciation deduction for Federal Income Tax purposes.Prior to that time, 21 the Company treated these accounts as nondepreciable
'and no 22 23 depreciation accrual was made to the book reserve for these accounts.Changes in the selection of average life, curve type and net salvage percentages based on experience since the 1969 study and judgment have created the relatively minor differences between the calculated reserve and the book reserve in the other functional plants.Since our 1969 study, the difference between the calculated reserve and the book reserve r has increased from about 1 percent of depreciable plant to 10 about 2.5 percent.As discussed on page 187 of Reilly Exhibit No.2, I feel that the proper treatment of this difference at this time is to adjust the normal annual recommended depreciation rates to include an allowance that will adjust for this difference over 12 the average remaining life of each functional plant in which a 13 14 difference exists.The computation on Schedule I derives the composite recommended depreciation rates for 1975'or each 15 functional plant, including this adjustment.
The calculations 17 on Schedule II in this exhibit determine the actual amount of normal depreciation based on plant in service at December 31, 18 19 1974.By"normal" we refer to that amount of depreciation
\using rates that are based on the average service life and net 20 salvage factor only.To this amount, I added the amount 21 necessary to amortize the difference between the'calculated 22 reserve-and the book reserve per Schedule.III to determine the 23'4 total depreciation from which the recommended rates have been derived in Schedule I for the year 1975.
1 Q.Mr.Reilly, can you summarize for us the effect of CP&L adopting 2 your recommended depreciation rates?3 A.The adoption of my recommended depreciation rates, together with 4.the amortization of the difference between the theoretical depreciation reserve and the book reserve as of December 31, 1974, will allow the Company to recover its investment in Electric Plant in Service in a rational and uniform manner over the remain-ing life in a plant in service estimated by me as of December 31, 1974.
4 10 A.My primary responsibility was the assignment and allocation
)of rate base components, revenues, expenses, and capital structure to the South Carolina retail operations, which are subject to the jurisdiction of this Commission.
The results of these assignments and allocations are shown on the various test period exhibits filed in this proceeding.
The original Applications were based on a 1974 test period.Subsequent to the filing of the original exhibits, the test period has been updated to the year 1975.The revised exhibi.ts for the 1975 test period are presented in the testimony of Mr.Bradshaw and Mr.Davis, to whom I furnished the results of the allocation of 13 the system totals to determine the amounts for the South Carolina retail operations.
14 I was also responsible for preparation of the 1974 Retail 15 Operations Cost Allocation Study based on the present rates annualized.
This study provides an indication of the relative 17 rates of return earned by the various retail customer rate 18 19 classes.My testimony'will include a discussion of the proce-dures used to accomplish the study and the results obtained 20 for the retail rate classes.21 Q.Were the allocations to obtain the South Carolina retail 22 jurisdictional operating results accomplished under your super-23 vision and direction?
24 A.Yes, they were, and they consisted of methods previously 25 presented to this.Commission.
In summary, I would state that the power supply allocation was accomplished on the basis of coincident peak demand.This allocation method states the power supply responsibility for production and transmission cost on the.basis of the demand at the time of our annual summer peak demand.We believe that this method properly reflects the cost of providing service and relates our revenue levels to the peak load of our system.We have used this peak load cost formula in our last two rate filings prior to this case and recommend its approval again in this 10 proceeding.
The allocation of the remaining cost items was accomplished in the same manner as in our previous rate filings.12 Q.Would you please explain the jurisdictional allocation study in 13 more detail?14 A.The results of system operations including adjustments were 15 apportioned to retail service in South Carolina by a series of 16 17 18 19 20 21 steps which began with a study to identify those items related solely to service to specific classes of customers.
Those items were then assigned directly to the related classes.Those matters which arose from joint-use and thus could not be assigned directly to specific classes were allocated by the application of standard analytical methods.All items were grouped according to 22 the functions to which they relate-production, transmission, 23 distribution, administrative and general, sales and customer accounting.
Allocable items were also classified as to whether they'were demand-related, energy-related, or customer-related.
Allocations of demand-related items were made using coincident peak demand factors.Energy-related items were allocated by using kilowatt-hour ratio factors.6 Q.Will you please explain briefly how each major revenue, expense, 7 and rate base item was allocated, beginning with operating 8 revenues?9 A.Operating revenues from sales at retail in South Carolina are 10 readily identified and therefore have been assigned directly to the South Carolina retail class.Other operating revenues consisting of a number of miscellaneous items were either 13 assigned directly or apportioned by appropriate analysis and factors.Q.Please describe the allocation of the operation and maintenance 16 expenses.17 A.Before the operation and maintenance expense items could be 18 functionalized into categories for allocation, it was necessary 19 to prorate the supervision and engineering expenses for each 20 expense account.An analysis provided the amount of the payroll 21 22 23 24 25 charges included in the total expense items.The respective supervision and engineering expenses were then apportioned to the various expense accounts based on this labor component.
By this means the primary accounts were restated to include a pro-rated portion of the supervision and engineering expense.
10 12 The expenses as thus restated were then classified as either energy-related, demand related, or customer-related.
The production expense items classified as energy-related are fuel, the energy portion of purchased power, boiler plant maintenance, electric plant maintenance, reactor plant maintenance, and nuclear electric plant maintenance..
The remaining power production expenses were classified as demand-related.
The transmission expense was assigned b'etween power supply production and power supply transmission based on the ratio of the plant in service.The distribution expense was divided functionally between substations, overhead lines, underground 13 lines, meters, and other distribution expense.These function-14 15 alized expenses were assigned to each state and then allocated to,the jurisdictional classes within the states on the basis of 16 the respective distribution plant accounts.The customer accounting expense was assigned based on a 18 specific analysis which separated the cost involved between 19 20 21 22 wholesale and retail service in each state.A portion of the expense of the customer services personnel who are directly involved in wholesale sales was assigned to the wholesale operation in each state.The remaining sales expense was 23 assigned to the retail class.
Regulatory expense has been analyzed and assigned to the respective jurisdictions.
The remaining administrative and general expenses were allocated to the customer classes principally by the use of labor factors.Certain items such as property insurance and maintenance.
of general plant were allocated on plant ratios.The operation and maintenance expense adjustments were allocated on the same basis as the items to which the adjust-ments related.'0 Q.Would you please explain the allocation of the depreciation 12 A.13 14 15 16 expense?Depreciation expense was assigned in accordance with the assign-ment and allocation of the functional plant to which the depre-ciation related.The adjustments to the depreciation expense were similarly functionalized and allocated on the basis of the respective functional plant account.17 Q.Please describe the allocation of the remaining operating 18 19 A.20 expense items.Taxes other than income were assigned for allocation as related to labor, property, KWH sales, or revenue and were then allocated 21 by the respective allocation factors.Unemployment taxes were 22 23 considered labor-related, property taxes were considered related to plant investment, the South Carolina electric power generation 24 25 tax was classified as KWH-related, and revenue taxes such as the North Carolina gross receipts tax were treated as related to 26 revenue.
State income taxes were assigned specifically to the respective states and then allocated to classes on the basis of the ratios of income before taxes.Federal income taxes were calculated for states and for classes using allocated taxable income.The provision for deferred income taxes and the investment tax credit were functionalized into production, transmission, distribution and general categories, and then 8 allocated on the basis of the respective plant allocations.
9 Q.Will you please explain the allocation steps used to determine 10 the portion of the electric plant used in providing service to ll South Carolina retail operations?
12 A.The allocation of electric plant in service consisted of two 13 14 as basic steps.The first step was to specifically assign all items of cost for which sufficient information allowed a specific separation between classes.This step involved separating the 16 cost associated exclusively with the wholesale operation and also 17 18 19 joint costs which were allocated on a specific basis.The second step was to allocate the costs where the joint use was so thorough that a specific analysis was not practical.
These costs were 20 assigned for allocation to the classes of service and the alloca-21 22 23 tions were accomplished by the use of allocation factors developed for the respective classes.Allocations of the power supply production and.power supply 24 transmission facilities were accomplished using the coincident peak demand allocation factors.All allocations of facilities below the level of power supply transmission were accomplished by use of NCP demand allocation factors.The NCP factors for each of these specific allocations were developed by an analysis of the demands imposed on the facilities being allocated.
The production plant in service was allocated between classes of service by KW demand allocation factors developed from system load data.These KW demand allocation factors were based on data adjusted to the production level.No production 10 plant account dollars were specifically assigned to classes of 12 13 14 15 16 18 19 service.The transmission plant in service was allocated between the classes by KW demand allocation factors developed from system load data.No transmission plant account dollars were specifically assigned.It was necessary, however, to separate the transmission plant into two levels for allocation by KW demand factors.Since the function of the step-up trans-formers at the various generating plants is considered to be production, these facilities were allocated using the production KW demand allocation factors.All other transmission facilities 20 were allocated using transmission KW demand allocation factors.21 22 23 The investment in distribution facilities was assigned between the states on a geographical basis as shown directly on the books of the Company and between the wholesale and retail 24 classes on the basis of specific analysis.General plant was first placed in the functional categories in its relationship of use with the production, transmission, or distribution facilities.
The amounts thus functionalized were then assigned on the same b'asis as the respective functional plant accounts.The item for intangible plant was assigned on the basis of the other electric plant.The depreciation reserve distributed on the books to the functional plant from which it results was assigned in accordance with the plant assignment.
10 Q.Would you please now describe the allocation of the other rate base items?12 A.Net nuclear fuel, which consists of nuclear fuel assemblies in 13 14 15 17 18 19 20 21 the reactor, nuclear fuel in process, and spent nuclear fuel, was allocated by the use of KWH energy factors.The fuel portion of materials and supplies was allocated by energy factors.Other.materials and supplies were analyzed as to their type and were allocated according to the assignment of related plant.The bank balance portion of the cash working capital allowance was assigned in accordance with plant investment.
Prepayments were assigned by specific analysis or by allocations based on gross plant.The cash allowance was assigned in the same proportion as the operation 22 and maintenance expenses.Deducted from cash working capital were 23 24 25 average tax accruals and customer deposits.The tax accrual offset was allocated in accordance with plant investment.
Customer deposits were directly assigned to the proper jurisdiction.
1 g.Where are the results of applying these allocation procedures 2 to the 1975 test period shown in this proceeding?
3 A.The results of my 5urisdictional allocation study are shown in Davis Exhibit No.1.I provided to Mr.Davis the South 5 Carolina retail allocated portion of the cost of service that 6 he is presenting in his testimony.
7 g.Will you please now turn to the next part of your testimony 10 relating to the procedures and results of the Retail Opera-tions Cost Allocation Study for the 1974 test period.Please summarize what is meant by a retail operations cost allocation 11 study.12 A.A retail operations cost study allocates system cost and devel-13 14 15 16 17 18 19 20 22 23 ops a rate of return for each of the retail classes.The study allocates the revenues, expenses, and rate base between the various retail classes.The rate of return is derived by measuring net operating income as a percent of average net original cost rate base.Horne Exhibit No.1 describes the procedures that are used in our retail cost allocation studies.The methods and)udgment used in our retail cost allocation studies are extensions of the methods used in the preparation of jurisdictional allocation studies.While advice for portions of the study is obtained from consultants, the studies are accomplished by Company personnel.
Recognized and accepted allocation procedures are used through-out the studies.For the major components, these procedures conform to those used in the recent rate hearings before the regulatory commissions in the two states which the Company serves.6 Q.How were the cost data and customer information obtained to 7 apply these allocation procedures in the retail studies?A.The basic cost data for the study were taken from the books and 10 12 14 1S 16 records of the Company.Adjustments have been made to include the effect of known changes during the year.However, these adjustments do not include all the items that would be necessary if the results of this type of study were to be used to determine the rate levels of the Company.Fundamental to appraising the results of this type of allo-cation study is a recognition that the use of an average original cost rate base without all of the adjustments normally 17 included in a ratemaking proceeding is appropriate in a study of 3.8 the relationship of rates to each other but not in considering 19 the adequacy of the overall rate of return.20 Q.Was the document marked Horne Exhibit No.2 prepared by you or 21 under your supervision and direction?
22 A.Yes, it was.(Identify) 23 Q.What is shown in this Exhibit?24 A.This Exhibit presents the results of our Retail Operations Cost 25 Allocation Study for the year 1974 on the basis of the present 26 rates annualized.
1 Q.Does this Study for 1974 provide the information which is 2 necessary in the establishment of the rates for the various retail classes of service?4 A.No.This Study only provides an indication as to the relative 10 rates of return that are being earned by the various rate classes.It attempts to analyze and consider cost factors in providing service to the various customer classes.This study, however, does not consider all of the factors which are essential in setting rate levels and the design of the resulting rate schedules.
The end results of the accounting and the engineering 12 13 14 procedures involved in cost allocation studies do not establish value of service or even levels of reasonable rates.The results simply reflect the total cost assigned to the rate 15 16 classes by following basic principles with logical and supportable procedures starting from the premise of allocation 17 18 19 20 21 joint costs.The resulting rates of return can serve only as a guide, under the assumptions of the study, to the relative earnings of the various rate classes.Proper rates can be established only after consideration of all the factors rele-vant to their justness and reasonableness.
A retail class cost 22 allocation study is one of the aids in that task.
South Carolina Public Service Commission CAROLINA POWER&LIGHT COMPANY TESTIMONY OF JAMES M.DAVIS, JR.1 Q.Please state your name and address.2 A.James M.Davis, Jr., Raleigh, North Carolina.3 Q.What is your position with Carolina Power&Light Company?4 A.I am Assistant Director of Rates and Regulation.
5 Q.Will you briefly describe your educational and professional 6 background.
7 A.I am a graduate of North Carolina State University, from which 10'/I recei'ved a Bachelor of Science Degree in Mechanical Engineer-ing.After three years'ervice as an officer in the.U.S.Air Force, I was employed by Pratt and Whitney Aircraft as a test engineer in the Experimental Engineering Department.
In 1965, I went to work with Carolina Power&Light Company as an 13 engineer in the Special Services Section.I joined the Rates 14 15 16 17 and Regulation Department in February, 1968, and in July, 1970, I was named to my present position.My education in the ratemaking area has consisted of parti-cipation in the development of the load survey, cost analysis, 18 19 rate evaluation, and rate design programs of the Company.This work has included the studies that were necessary in the prepara-20 tion of the filings and case materials for retail and wholesale rate increase requests, including our Company's prior requests to 22 this Commission.
I have attended a training program conducted by Ebasco Services, public utility consultants, and I have worked with a number of rate consultants in the preparation of rate case material;I have attended meetings of the Rate Research Committee of the Edison Electric Institute.
I am a registered 5 Professional Engineer in the State of North Carolina.6 Q.Have you testified before a regulatory authority prior to this 7 case?8 A.Yes, I have testified before this Commission in prior rate 9 proceedings and before the North Carolina Utilities Commission 10 and the Federal Power Commission.
11 Q.Please summarize your duties with Carolina Power&Light 12 Company.13 A.The Department of which I am assistant director is responsible 14 for the development, issuance, and interpretation of the rates 16 17 18 19 and service practices of the Company.I am responsible to the Uice President and Director of Rates and Regulation for the direction and supervision of the studies underlying the theoretical and practical aspects of our rate structure; the preparation of rates and revenue comparisons; the direction and supervision of 20 cost allocation studies;and the development of financial and cost 21 22 23 24 studies for rate case presentation.
I supervised the rate of return studies underlying the exhibits which have been filed in this proceeding, and supervised the preparation of the proposed rates and rate schedules.
25 Q.Mill you please explain the scope of testimony you.intend to offer 26 here?
1 A.I will present the proposed rates, including.a fuel adjustment 2 clause for the recovery of current fuel costs, for which the 3 Company is requesting approval of this proceeding.
I will also 4 present the actual operating results of the Company.during the test period consisting of the calendar year 1975, with appropriate adjustments.
This material will be presented on both a system-wide basis and, as indicated in the testimony of Mr.Horne, as allocated and apportioned to the operations which are'subject to the jurisdiction of this Commission.
My 10 testimony will show the monetary effect that the proposed rates ll would have had on the Company's operations, as adjusted, had the 12 changes been in effect during the test period 1975.13 Q.Where have you shown the 1975 test period operating results with 14 the present rates in effect?15 A.~Davis Exhibit No.1 sets forth the operating experience for the 16 historical test period in this proceeding.
This Exhibit is in 17 the same format as Exhibit G filed with our Application and has 18 19 20 21 22 23 been updated to reflect the year 1975 results.Column 7 sets forth the allocated South Carolina retail operations.
The proce-dures used to obtain the allocations were described in the testimony of Mr.Horne.This Exhibit shows the actual 1975 test period operations
'adjusted to properly reflect for the purpose of jurisdictional 24 ratemaking those changing conditions which were not fully reflected in the actual results of the test period.Included therein, are those proforma adjustments explained in the testimony of Mr.Paul Bradshaw.In addition, I have included certain adjustments which were calculated under my direction and supervision.
These adjustments include the annualization for the effect of previously allowed rate 6 increases and the normalization and annualization of the'7 addition of the Brunswick No.2 generating unit.8 g.Will you please explain the adjustments which you have 9 included;starting first w'ith the adjustment for prior rate 10 increases?
11 A.During the test period 1975, the Company received a retail 12 rate increase which was not fully reflected in the test 13 14 15 16 17 year revenues.It was necessary to compute the annual effect'of this approved increase and add to the test year revenues the additional revenues that would have been produced had the approved increases been in effect throughout.
the test period.These adjustments restate the test year revenues to 18 reflect fully the effect of the prior rate increases which 19 occurred during the test period.20 21 The second adjustment which I have included adjusts revenues, expenses, and rate base to reflect the full annualization of the 22 23 addition of the Brunswick No.2 nuclear generating unit.This adjustment is essential to state the operating results'of the 24 Company on the basis of a full year's operation of this new generating resource.The adjustment includes many aspects to fully reflect the effect on our operating results from the addition of Brunswick No.2.Each respective ad)ustment to revenues, expenses, and rate base was computed on the basis 10 of the Brunswick No.2 unit operating at a 72%capacity factor during the test period.This availability was selected because it reflects a full year's operation, including a refuel-ing cycle.We selected a 72%capacity factor on the assumption that the unit would be available on a basis equivalent to ful'1 power operation approximately 85%of the hours during the year, 12 except'for a six-week outage for necessary maintenance and refueling.
This reflects an optimistic estimate of the avail-"13 14 ability of this new unit and reflects a'full year's operation at a substantial availability and load factor.15 In order to compute the effects of the availability of 16 Brunswick No.2 for the entire test period, it was necessary to 17 develop a power estimate which would restate the generation from 18 19 system resources to include the addition of this large nuclear unit.Purchases and interchange transactions were also 20 analyzed to determine if purchases could have been reduced to an 21 22 23 economic advantage if the nuclear unit.Sad been available.
When this analysis was completed, the result stated the adjusted generation from each of our existing units.This reduced'genera-24 tion was then analyzed to determine the fuel requirements that would have existed with the reduced generation.
Our fossil fuel purchases during the year 1975 were reviewed to determine the effect of the fossil generation which would have been replaced by the nuclear unit.In order to evaluate the fuel purchases, we eliminated the highest price spot purchases that were made in each month at each of the plant locations based on the reduced generation for that respective plant.We did not reduce contract purchases at any of our plant locations.
The reduced fuel purchases were then processed through our 10 12 13 14 16 17 18 19 20 21 fuel inventories to determine adjusted unit fuel prices.The adjusted fuel prices were then used as a basis to calculate fossil fuel adjustment factors that would have resulted from the adjusted fuel purchases and consumption.
This calculation was necessary to reduce the revenues that would have been'roduced by the fuel adjustment factor.The completion of these detailed calculations to fully annualize the operation of the Brunswick No.2 nuclear unit resulted in the following adjustments.
South Carolina retail revenues were reduced by$5.0 million.The test year fuel expense was reduced by a net of$4.3 million.Purchased power expense was reduced by$1.0 million.Other 0&M expenses were 22 23 increased by$711,000.Depreciation expenses, property taxes, fuel deferral, and working capital were also adjusted to con-24 form to the related adjustment items.The combined effect of these adjustments was to state the test year on the basis of a full annualization and normalization for the addition of Brunswick No.2 generating unit.The adjustments to fuel 4 expense and purchased power have also been included in the base cost for the proposed fuel adjustment formula in Davis Exhibit No.3.7 Q.Mill you please describe the rates proposed by the Company in 8 this proceeding?
9 A.The Company has filed two rate increase applications in this'A 10 12 proceeding.
On July 31, 1975, an application was filed for authority to adjust the rates for residential service.The effect of this initial application was to equalize the rate for 13 residential service between the state of South Carolina and 14 15 North Carolina.The Application was assigned Docket No.18,361,'I and the proposed rates went into effect under bond, subject to 16 17 18 19 20 refund, on September 1, 1975, in.accordance with the Commission's Order No.18,532.On August ll, 1975, the Company filed an additional Appli-cation requesting a general increase in its rates and charges for retail service in South Carolina.This Application was 21 22 23 assigned Docket No.18,387.Subsequent to the filing of the general application, the Commission consolidated the two dockets into one proceeding.
Exhibit B filed with the Application on August 11, 1975, contains the rates and rate schedules proposed by the Company.For convenience, the proposed schedules are 10 13 14 15 16 presented with this testimony as Davis Exhibit No.'.It should be noted that these schedules contained a"roll-in" of 5.54 mills per KWH to reflect an increase in the cost of fuel reflected in the base rate charges.At the time of the filing, it appeared that this level of cost was a reasonable expectation for, the current cost of fuel.However, the Company's experience has been more favorable, and the cost of fuel has stabilized at a level below the requested roll-in figure..As a result of this improvement in the cost of fuel, an adjustment was made at the time the requested rates became effective under bond for service rendered on and after March 1, 1976.Rider No.35A, which has been included as a part of Exhibit B, was placed into effect to reduce the requested rates by$0.005536 per KWH t'o remove the roll-in requested by the Company and allow the 17 presently approved fuel clause to continue in effect.18 Q.Does the Company propose that the filed rates continue in effect on 19 a permanent basis including Rider No.35A to adjust for the 20 difference in fuel cost?21 A.No, we do not.We have simply made an adjustment to allow the I filed rates to go into effect on an interim basis, pending a 23 decision of the Commission as to how the rates should reflect a 24 reasonable current cost of fuel.If the present Fossil Fuel Adjustment Clause Rider No.32B were to remain in effect, it would be desirable to adjust the kilowatt-hour charges in each I rate rather than to continue the adjustment through Rider No.35A.It would also be possible to raise the base cost reflected in the fuel clause and adjust the charges in the basic rates.This would reflect a lower roll-in than originally requested by the Company but would raise'he base of the fuel clause above its present level.'0 12 13 14 In addition to the originally proposed rates and adjust-ment to the fuel charge roll-in, I will present an alternative method for the recovery of fuel costs in excess of, those reflected in the base rates.This alternative method would include a fuel adjustment clause based on changes in the cost of fuel, including nuclear fuel.Later in my testimony, I will 15 present the specifics of the development of this fuel adjustment 16 17 clause and will present proposed base rate schedules that would be necessary to implement this alternative method of recovering 18 total fuel cost.19 Q.Is the Company proposing or requesting any additional change 20 related to the application of the fossil fuel charge7 21 A.Yes, we are.We would request that the fuel charge approved by 22 24 the Commission in the proceeding be applied to the non-metered sales, including the lighting classifications.
At the present time, the fuel charge only applies to metered sales.We have developed an administrative procedure by which the charge can be applied to non-metered sales on the basis of the estimated kilowatt-hour usage which'is used in establish-ing and reporting sales under the basic rate.Me are requesting Commission approval to apply the fuel charge on 6 the basis of this procedure which would be consistent with 7 the present practice of the other major utilities in this 8 jurisdiction.
9 Q.Do the rate schedules that you are presenting provide for a 10 uniform increase among the customer classes.11 A.No, they do not.The rate increases proposed in this 12 proceeding are not on an across-the-board basis, but vary/13 with regard to recent financial results from the various 14 customer classes.The re'lative increases to the classes 15 seek to recognize the areas of cost differences in providing 16'ervice and are based in part on the results of our most 17" recent retail operations cost allocation study.18 At the time of the preparation of the rates filed in this 19 proceeding, the results of the 1974 cost of service study were.20 21 available.
These results which indicated the relative rates of return between the retail rate classifichtions were used as one 22 23 of the guides in determining the percentage increase for each customer class.
10 12 13 14 On the basis of 1975 sales the average percent increase on the retail classification on total charges, including fuel revenues, is approximately 27%.On the basis of an average 27%rate increase, there are variations within the various customer classes.The residential class will receive a total increase of about 32.5%.This increase is a combined total of the two requests in this proceeding.
The higher-than-average increase also reflects the fact that the residential class rate of return is below the retail average.The small general service class will receive an average increase of 20.5%.The lower-than-average increase is in recognition of the fact that the rate of return for this classification is above the retail average.The large general service rates would receive an increase of 26%, which is slightly less than the average retail 15 increase.The schedules for service to the lighting class of 16 17 18 19 20 customer will receive an average increase of 16.45%.This is the lowest increase that can be applied to the customer class consistent with the receiving of fair rate of return from the classification.
As a result of the Company's rate history and of its prior 21 marketing policy, which produced very successfully a balanced 22 system load with a high growth at a time when those aspects were 23 24 beneficial to our customers, the Company has a relatively large number of existing rate schedules for retail service.A primary objective in our prior rate proceeding was the reduction of the number of our retail schedules.
We proposed and received Commission approval to eliminate a net of six rate schedules in our prior case.We would propose to continue this improvement in our rate structure by the elimination of four additional active rate schedules.
We are proposing to administratively freeze the availability of three rate schedules, RF-1, AH-1, and 10 12 13 14 15 17 18 19 20 21 22 23 24 25 SC-1.To avoid severe financial impacts on the present customers served under these three rate schedules, we are not requesting the immediate transfer of the present customers to other rate schedules.
We are proposing instead to limit the availability of the schedules to the existing customers and to place a higher-than-average increase on these rates in order to move the charges into closer alignment with our General Service Rates.It is anticipated that over a period of time, the customers, because of changing load characteristics and differences in the existing rates, will move to the general service rates, and it will be possible in future rate filings to complete the process of eliminating these three schedules.
We are requesting the elimination of the House Construction Rate Schedule, HC-1.This rate provides temporary service during the construction of residential housing units.We would propose to replace Rate Schedule HC-1 with our standard Small General Service Rate, G-l, and serve the builder on the general service rate until the permanent service is installed for the residential unit.At the time the permanent service is installed to the residence, the residence would then be billed on the standard 4 residential rate for which the residence qualifies.
This will 5 eliminate the need for a separate rate schedule for service dur-6 ing the time the house is under construction.
This change will 7 improve our rate administration and limit the availability for I 10 temporary service to our standard small general service rate.This proposedprocedure will have a significant financial impact on the existing HC-1 customers.
The rates presented in Davis 12 Exhibit No.2 containing the modifications described above and others set out therein constitute a set of just and reasonable 13 14 rates appropriate for our Company and the various-types of customers in our service area.15 Q.Will you please describe the manner in which the proposed rates 16 recover the fuel expense of the Company?17 A.The rates proposed in this proceeding were designed based on a 18 19 20 21 22 23 24 total fuel cost component of 1.010 cents per kilowatt-hour.
The rates were designed during 1975 and reflected average fuel costs experienced during 1974.The 1975 test year fuel expense when annualized for the operation of the Brunswick No.2 nuclear generating unit is below the fuel cost level designed into the rates originally filed in this proceeding.
A lower cost of fuel would be more appropriate in setting rates at this'time.'13-10 12 A fuel cost level of'8.60 mills per kilowatt-hour sales is a more appropriate level to reflect current costs in the design of the rates.Davis Exhibit No.3 is a fuel adjustment clause which we would propose for the consideration of the Commission.
As indicated in the exhibit, we have established 8.50 mills per kilowatt-hour as the base cost for the fuel adjustment clause to include both nuclear and fossil fuels and the effect of purchase and interchange power.Me would recommend this clause to the, Commission to replace the present adjustment clause which recognizes changes only in fossil fuel costs.Since the base cost of fuel reflected in this fuel adjustment 13 clause is below the level of 1.01 cents per kilowatt-hour 14 15 16 included in the original filed rates, it.is necessary to adjust the base rates to which the clause would be applicable.
Davis Exhibit No.4 is a set of alternative rates which have been 17 adjusted to reflect the base cost included in the proposed 18 19 20 21 alternate fuel adjustment clause.These rates are identical to the rates approved for service in our North Carolina territory.
Approval of this set of rates and the accompanying fuel clause would return the Company to uniform rates,'throughout its retail'22 service area.23 Q.Did you use the results of the 1974 retail cost allocation study 24 in the design of the rates requested in this proceeding?
1 A.Yes, I did.The relative relationship of the rates of return among the various customer classes, and,'..to a lesser extent, 10 13 the individual rate schedules, was used as a guide in the distribution of the rate increase among the customer classes.As we have testified in earlier rate proceedings, we are committed toward moving our rate structure and designing our rates in such a manner as to produce a more uniform rate of return among the retail classes.We made considerable pro-gress in our last rate case in applying the increase such that the rates of return would move toward the overall retail average.We have attempted to contine that movement in this rate case.It should be recognized, however, that there are 14 restraints against moving directly to a uniform rate of return 15 among the various customer classes.These restraints include 16 the relationship between the individual rate schedules, the 17 18 19 20 21 22 23 overall revenue requirement and the revenue effect on individual customers.
It is necessary and desirable to make the transition and changes in the rate schedules on a gradual and smooth basis, rather than introduce abrupt changes.We tried to design our rates within all of those restraints and make as much progress toward a uniform rate of return as these conditions would allow.Even without the restraints that exist in abrupt rate 24 changes, it would not be desirable to structure our rates to 25 produce a uniform rate of return on the basis of one test period.
This is true because the equal rates of return would be'measured by a historical test period and would not exist when the rates became effective.
It would not be possible to measure the result-ing variation in rates of return until the rates had been in effect and a cost study performed at a later date.It is there-fore desirable to set the rates of return within a reasonable range rather than seeking absolute uniformity on the basis of a 8 past test period.In the application of the requested rate 9 increase, we have improved the variation from the average retail 10'ate of return for each of the customer classes.ll Q.Please describe the manner in which the rates requested in this 12 proceeding were designed.13 A.The first step in the design of the requested rates was to 14 15 16 17 18 19 20 21 22 23 24 distribute the required additional revenue among the retail classes on the basis of the results of the retail class alloca-tion study and in proportion to each class based on its percentage of the Company's revenues.It was proposed in the case of the residential class to apply an increase necessary to bring the residential class rate of return to a point closer to the retail average return.It was likewise concluded to apply less than the average increase to the Small General Service class in order to continue the movement of the rate of return from that class down-ward toward the retail average.It was proposed to apply'the minimum increase to the lighting classification necessary to bring 25 the rate of return slightly below the retail average.Slightly less than the overall average increase was applied to the Large General Service classification.
The results of these computations were to determine a revenue requirement for each of the retail classes.The rates were then designed within those classes to produce the total revenue requirement, and to maintain the proper alignment and relationship between the rates.In the case of general service rates, the most signifi-cant design feature change'as to incorporate in both small and 10 large rates which include a separate demand charge a 12-month seasonal ratchet to establish the minimum billing demand.This 12 13 design change was made to increase the amount charged for demand in order to create more incentive to conserve electricity.
14 The new billing demand feature establishes the minimum 15 16 17 18 billing demand based on 90%of the customer's maximum demand in the prior summer peak months of July through October.This form of pricing encourages customers to reduce their demands during the summer peak period.In addition, a billing provision has 19 been established as a minimum of 50%of the demands during the 20 off-peak winter season months;and as an administrative iequire-21 ,ment,.a minimum of 75%of the contract demand until such time as 22 the actual demand equals the contract demand.This total ratchet 23 provision enables the customer to control his billing demand by 24 reducing his consumption during peak periods.It establishes a


12-month ratchet rather than the previous provision in our schedules.
South Carolina Public Service Commission DIRECT TESTIMONY OF SHEARON HARRIS 1    Please state your name, address          and  occupation.
The definition of contract demand has been'evised in the proposed rate schedules and service regu-4 lations to conform to the new ratchet provision.
2 A. Shearon  Harris. My  office    address    is  336  Fayetteville Street, Raleigh, North Carolina, and    my  occupation    is  Chairman of the Board, President and   Chief Executive Officer of Carolina Power            &  Light Company  (CP&L).
5 Q.Have you shown the results of applying the proposed rates to 6 the individual customer classes?7 A.Yes, I have.Davis Exhibit No.5 presents a summary of the 8 results of the cost allocation study indicating the rates, of 9 return for the retail classes that would have been realized 10 12 during the 1974 test year if the requested rates had been in effect during the entire period.It should be noted that these rates of return are valid only for comparison of relation-13 ship between the rates and do not indicate the correct rate of 14 15 return for)urisdictional ratemaking.
5 Q. How  long have you been associated with Carolina Power              & Light  Company and what    positions have you held with the           Company?
A comparison of this exhibit with Horne Exhibit No.2 would indicate that the 16 proposed rates improve the variation from the retail average 17 from each of our rate classifications.
7 A. I joined    the Company  in  December    of  1957 as Associate General Counsel and  I became a  Vice'President in 1960.         I  served as General Counsel from the   latter part of 1962 until May of 1963 at which time I was 10    elected  President. I was designated Chief Executive Officer in January 1969 and in March of 1970          I was  elected Chairman of the Board    .
18 Q.Have you shown the results of the proposed rates'n a 1975 test 19 year basis?20 A.Not on a retail class basis.The 1975 retail cost of service 21 22 study had not been completed and the results were not available't the time of the preparation of this testimony.
12     Would you    briefly  review    some  of your experience in the       utility industry 13      and  in the business community.
The initial 23 rate design was based on a 1974 test period, and the results I 24 25 have shown for the retail classes are based on the 1974 cost of service study.
14  A. I  have served as Chairman      of the Edison Electric Institute, which is 15      the trade association of the investor-owned              electric  utility industry, Chairman  of the Board of Directors of the National Association of 17      Electric  Companies,  Chairman of the Southeast          Regional Advisory Committee 18      of the Federal    Power Commission, member        of the Board of the National 19      Association of Manufacturers and of the Executive Committee of the Business 20      Round  Table, and as  an  officer or active        member  of various other industry 21      boards and committees.        I  am  presently serving      as Chairman  of the Executive 22      Advisory Committee for the National Power Survey conducted by the Federal
1 Q.Will you now please describe the monetary effect that the 3 proposed rates would have had on the Company's jurisdictional operation as adjusted had the proposed rate changes been in effect throughout the 1975 test period?5 A.These materials are shown on Davis Exhibit No.6.Column 2\6 of Page 1 of this exhibit is identical through Line 25 with 7 Column 7 of Davis Exhibit No.1.For convenience, it restates 8 the actual operating results with appropriate adjustments 10 apportioned to the South Carolina retail operations.
 
Column 3 sets forth the effect of the proposed rates had they been in force throughout the test period.As shown thereon, the addi-12 tional revenues would have been about$22,486,985.
Power Commission,    Chairman  of the Electric'ower Research Institute
Additional 13'4 15 gross receipts, state and federal income taxes arising as a result of these additional revenues, would have amounted to$11,528,321 or 51.27%of the gross revenue increase.The addi-16 tional net operating income for return would have been 17$10,958,664.
                                                              '\
Thus, with the increase applicable to South 18 Carolina retail sales, the net income for return, including 19 customer growth, would have been$31,055,486, as shown on 20 Line 18 under Column 4.21 Q.What else is shown on Page 1 of Davis Exhibit No.82 22 A.Lines 19 through 30 show the original cost net investment 24 consisting of net electric plant in service, plus an allowance for working capital.The total original cost net investment is shown on Line 30.As stated there, the apparent return in the test year at the present rates would have been 5.98%;and had t the proposed rates been in effect for the entire test period, this indicated rate of return would have been 9.27%.5 Q.What rates of return would have been indicated in the test year 7 A.common equity?As indicated on Page.3 of Davis Exhibit No.6;,the requested 10 rates would have produced 12.18%on actual common equity in the test period.This corresponds to an allowance in our prior rate order of 12.50%.ll Q.Is it your testimony in this proceeding that Carolina Power&12 13 Light Company will realize from the requested rates a return of 9.27%original cost rate base and 12.18%on total book equity?14 A.No, it is not.Mr.Harris and other witnesses have testified in 15 16 17 18 19 20 this proceeding to the fact that economic conditions will operate to prevent the Company from earning the rate of return allowed by this Commiss'ion on a historical test year basis.Even though the test year rate of return computations indi-cate a return on equity of 12.18%, the Company will not have an opportunity to earn that rate of return.The rates did not go 21 into effect in the full amount of the increase until March 1, 22 1976.-20-}}
and  serve on the Board of the United States Chamber of Commerce, and as a Trustee    of the Committee    on Economic Development.        I am also  a member  of the Business Council.
5 q. Would you  describe generally the service area, the operating system 6    and  electr'ic facilities of    CP&L.
7 A. CP&L  provides electric service at    retail  and wholesale throughout a 8    service area of about 30,000 square miles, covering the northeastern r
area of South Carolina much of central and eastern North Carolina 10    and  the Asheville area    . The  population of CP&L's service area is approximately 3,000,000.      At the end of March 1975, our        retail  customers 12    numbered approximately 663,000.        About 86 percent      of our revenues are 13    from  retail service. At the end of 1975 the Company's generating 14    capability  was about  6,800,000 kilowatts derived from seven coal-fired 15    steam  electric plants, the Robinson nuclear unit, Brunswick nuclear 16    unit No. 2, thirty-three internal combustion turbine generators and four hydroelectric plants.        During 1975 the Company's generation by 18    energy source was 72.5 percent coal, 22.4 percent nuclear, 3.8 percent hydro, 19      .1 percent residual    oil,  .4 percent No. 2  fuel oil    and .8  percent natural 20    gas. In 1976 the Company estimates    its  generation by energy source        will 21    be  approximately  67  percent coal, 30 percent nuclear, and        3 percent hydro.
22    The  capability of our    system including net power available on a          firm 23    commitment basis    is  about 7,000,000  kilowatts.      We  also  own and  operate.
24    an  integrated transmission network      and  distribution    system throughout I
25    the service area.      The Company's  facilities  are interconnected at
 
various points with the systems of neighboring        utilities in  order to provide for an interchange of power.      Our system and    operations are more  fully described in  the 1975 Annual Report, which is presented here as "CP&L Harris Exhibit No. l."
When was CP&L  last granted general retail rate relief for its          South Carolina operations?
7 A. The Company was  last granted general retail rate relief in South Carolina in  a  case filed in October, 1973, by order of this Commission dated January 15, 1975    in  a proceeding  that  was based upon a      test 10    period ending December 31, 1973.
11 Q ~ What has happened    since the rate proceeding to the Company's credit 12    rating?
13 A. In February of  1975 Moody's  Investors Services, Inc.,      one  of the nation's 14    major rating agencies,    downgraded CP&L's bonds from A      to  Baa. I know of no 15    other time in the history of the    Company  that  a  major rating agency has 16    assessed  the quality of the Company's securities as below investment 17    grade.
18 Q  Would you  elaborate on the effects of the lower bond rating.
19 A. The consequences    of this lowered bond rating are far-reaching        and 20    continuing. Many  financial institutions  and  investors are    now 21    prohibited by their charters or by established policy from investing 22    in  CP&L bonds. For example, pension funds    for  many public employees 5
4 23    are precluded by law from purchasing      the Company's bonds as a      result 24    of our low bond rating.      Some institutions  have been precluded from investing in our securities because of the low earnings coverage 26    of fixed charges which has been experienced.
 
During 1974 hearings in Docket No. 17,134            Company  witnesses predicted    many  harmful results should the Company's A/A bond rating be reduced.      The  results  have been even more adverse than then          anti-cipated  . At that time, the Company was anticipating a spread between the cost of marketing A and Baa bonds of about 35 basis points.                  In April of    1975,  after the downrating of      CP&L's bonds    in February, the Company    sold  $ 100  million in    first mortgage  bonds  at  a  cost to the Company    of 11.24 percent.      The most  nearly comparable sile by      a company with  an A/A    rating  was  that of Florida    Power and  Light    Company  at  a 10 cost of 9.08 percent, 216 basis points lower than              CP&L was  required to pay. We  pointed out in the 1974 case that        a Baa  rating  was 12 certainly not      one which would    attract investor interest in      30 year 13 bonds. When we  attempted  in April of    1975  to issue bonds to mature 14 in 30  years,    we  found that the    interest in  such bonds rated lower 15 than A by either of the major          rating agencies  was  almost nonexistent.
16 Consequently,      we had  to shorten the maturity date from the normal 17 30 years to only nine years.
18      We  also pointed out in 1974 that        a  lowering of the Company's 19 bond  rating    would  result in  a  prompt reduction    in the rating of the 20 Company's    preferred stock issues imposing substantially higher costs 21 in raising this type of capital.            This result has followed and the 22 Company's    preferred stock has also been downgraded by Moody's.              In 23 March  of 1975 the      Company  sold preference stock at a cost of 11.2 percent.
24 This compared to preferred stock sold          in the  same  period by companies 25 with  A  ratings for costs in the range of 10.25 percent to 10.36 percent.
26 Our Company was unable        to issue preferred stock at that time because 27 of low earnings coverage of preferred dividends            and  interest charges.
 
Not only has the    lowered"rating resulted in higher costs for long-term financing,      it has  substantially increased the cost which the Company would otherwise have to pay            for short-term financing.
The  Company's'ommercial paper rating was reduced from Prime 1 to Prime    2 at the  same  time the bond rating was reduced by Moody's.
To have    its securities    rated at below investment grade is exceedingly costly to the    Company and    its  ratepayers and    will continue  to be so for  as long as  this lower rating is in effect.
9    Would you please    state the objectives of the          Company's present  rate 10    filing.
ll A. Our  overall objective is to improve the seriously deteriorated financial 12    condition of the    Company so    that    we can  regain,  and once regained    thereafter 13    maintain our credit worthiness and continue to provide reliable service to 14    our customers.      Nore  specifically,      we are seeking increased revenues so that 15      (a) the Company's earnings coverage of fixed charges can be restored and 16    maintained at a more reasonable level of at least 2.5 times, (b) a fair  and  equitable return    may be earned      on the common  equity investment 18    in the    Company, and  (c) 'the  Company can    continue the normal maintenance 19    program    that was  reinstituted after the interim increases of          12  percent 20    became    effective  on  retail  sales in the    fall of last  year.
21 Q. Would you please    explain  why  the  Company  considers  it important  that 22    its  earnings coverage of fixed charges be increased and maintained 23    at  a  level of at least 2.5 times?
24  A. Because    this is the  minimum coverage which        in the opinion of the 25    Company    will enable its    bond  rating to    be  restored to A/A. This is 26    an  opinion widely shared in the financial community.
 
1 Q. Would you please    relate the    Company's recent coverage experience.
2 A. The Company's  earnings coverage of fixed charges          fell below  2  times 3    for the  12 months ending October 1974, and        notwithstanding the      full effect of rate increases      (based on 1973  test periods),    it continued to remain below    2  times through July, 1975.      This compares with earnings coverage of as high as 4.32        for the year  1968. As a resu1t    of interim rate  relief in  the States of North Carolina and South Carolina              last fall, the  Company's earnings coverage increased        to approximately 2.48
        .times  for the  12 months    ending March 31, 1976.      This increasing trend 10    is expected to level off      soon even though we continue      to collect    all of our requested increases subject to refund.            While our earnings coverage 12    may exceed  2.5 times    for  a  brief period,  it can  certainly not    be 13    maintained there for an appreciable period unless the            total rate 14    relief  requested in    this filing is allowed.      It is  very important to 15    note that the results      for this  period. are influenced greatly by the 16    interim increases that      have been    in effect in North Carolina      and 17    South Carolina since      last  fall and  by the  full increases    sought  in 18    both states which have been        in effect during    some  part of that period.
W 19    These revenues  have been confirmed by the North Carolina Commission.
20      Should we not be able to recover our        full requests    here, our  effort 21      to regain  and maintain our credit rating would be greatly frustrated..
 
Q. You have    stated as    a second  objective in your rate case        an increase in the rate of return to      a more  reasonable level.        Is  it your po'sition that the rate of return found      fair  and  equitable in the last rate 4    case  is  inadequate?
A. I must    answer  that by  first  pointing out that because of attrition and a  continued high rate of      inflation,    it has  been impossible    for the Company to earn the rate of return found by the Commission to be fair  and reasonable.      The Commission's      last rate order,    based upon a 1973    test period, concluded that the        approved rates should permit 10    CPGL  to earn  a 12.5%  rate of return    on  its common equity, which rate of return the Commission found to be fair and reasonable. During the 12    year 1975 the Company's actual rate of return on its portion of common 13    equity applicable to South Carolina retail operations was 10 percent.
This is substantially less than the rate of return which the Commission 15    considered as    just  and reasonable  in its order of January 15,        1975.
16    As shown on    the Company's revised Exhibit H, when appropriate adjustments 17    are made    this rate of return    becomes  less than    3  percent.
18          A more    specific  answer to the question      is that  I do  not consider 19    the former rates of return allowed on          common  equity to be adequate under 20    the circumstances      presently existing.      In the  first  place, during the 21    past year    it has  been  possible for purchasers of the Company's debt 22    securities to obtain returns in excess of            ll percent. Interest rates 23    on  long-term obligations have declined          somewhat    recently but  will 24    undoubtedly return to the high levels of            last year  as the demand    for 25    capital intensifies in the future.          It is  simply not    realistic to
 
expect to  attract equity capital    on reasonable    terms when the equity investor can from time to time obtain near1y comparable returns            on  other investments that are not faced with the challenges or the risks that
      ,
confront the    utility industry    today.
5  Q,  What  are  some  of the risks to which you refer?
6  A. First, I will mention      the deterioration that    is occurring in the quality of earnings. A debate continues    in the financial    community over the extent to which earnings containing a high allowance for funds used during construction    (AFDC)  are of a lower  quality than 'earnings that 10      are less dependent upon such allowances.        In  my  opinion, while earnings ll      resulting from    AFDC  are  inferior,  so long as  AFDC  does not comprise 12      an unreasonably    large proportion of total net earnings the overall quality 13      of earnings is not significantly affected.          However, since    AFDC  provides 14      no cash  flow, the risk exposure to investors in        a company's  securities 15      increases when    AFDC  accounts  for substantially    all  of the earnings of 16      the company. CP&L has  passed  that point,  and  in fact the large    amount 17      of  AFDC  included in CPSL's net income and the resulting small percentage 18      of the Company's cash needs generated internally contributed to the 19      downgrading of    its securities    by Moody's. A  study of  the'5    major  electrical 20      utilities  dated  April 29,    1975, by  Mitchell Hutchins, Inc.,    a  research 21      firm highly respected in the financial community,          showed CP&L as    the
: 22.      only  Company where AFDC exceeded      net earnings available for      common  stock 23      during the year    1974 . This situation resulted from the large amount 24      of construction work in progress upon which the          Company  realized  no 25      cash earnings.
 
As  of the year    end 1974, CP&L's      construction work in progress amounted  to  $ 826 million or    75  percent of net plant in service.        By May  31, 1975 construction work        in progress,had increased to    $ 948  million or approximately 86 percent of net plant in service.              Thus,  for every dollar of net investment of plant in service, the            Company had,  approxi-mately 86$ invested in construction work            in progress upon which    it received no cash    earnings.'t        the year end 1975, construction work in progress    still amounted    to  $ 643  million, notwithstanding the fact Brunswick No. 2 and  related facilities, which accounted for $ 403 million 10      came  into service    on November 3, 1975.
11            AFDC  increased to in excess of 100 percent of net earnings 12      available for    common  -stock  for the    12 months ending November, 1974, 13      constituted    97  percent of earnings available for        common for the    12 months 14      ending August, 1975, and continued at an exceptional 79 percent                for the 15      12 months    ending December 31, 1975.        This means that  in 1975, without 16      AFDC, .CP&L'had    earnings of only      $ .57 per share.,
17            The  fact that the    Company's    operating revenues have not been 18      producing    sufficient earnings to service        common stock is a  risk factor 19      which prudent investors must        certainly consider in determining whether
: 20. to invest in our stock or other securities.
21  Q. What  are  some  of the other risks associated with owning electric 22      utility equities    at the present time?
23'.
e The  delays and changes often involved in the licensing of generating 24      plants are unpredictable and costly.            Uncertainties relating to 25      environmental requirements,        and  potential costs associated with      such 26      requirements constitute      risks. The more  likely probability during      .
27      these times of high energy prices and often vocal consumer reaction 28      that governmental or regulatory action (or inaction)            will prove  harmful
 
                                                                      \
is  a  risk  which investors obviously consider.        The  possibility of adverse governmental and regulatory action constitutes              risks which 3      today's equity investors consider.
4  g. What  rate of return are you requesting in this proceeding?
5 A. We  are requesting rates that would produce additional revenue of 6 '22,486,985          annually. Based upon the 1975    test period, this would yield  a  return of  12.18% on common    equity. Because  of attrition and  continued    inflation,    we would  expect to actually earn less than 9      this indicated test year return.
10              As  our expert, Dr. John Langum,      testifies,  the  Company  should actually earn      a  rate of return    on common  equity of 14.5%.      This  is the 12      rate which      he  finds  fair  and reasonable  and  it is  also the rate which 13      the Company feels      is )ustified. Our original application in this        case 14      was  prepared to seek      a return  on  equity of this amount.      However, subsequent 15      decisions by the      Company  with respect to the normalization of certain 16      tax deferrals have resulted in          a decline in the rate of return which the 17      requested rates would produce.
18  Q. What consequences      do you foresee from a    failure to obtain the rate 19      relief    requested    in this proceeding?
20  A. A  failure to obtain all of the relief        would have serious adverse effects of    an immediate and    long-lasting nature.      Unless our A bond 22      rating is restored      by Moody 's,  it will be difficult, and      perhaps 23      impossible, to raise the amounts of capital required to continue our 24      presently planned construction program.            Even  if it is  regained,  it
: 25.      cannot be considered secure without the          total increase    -requested  in 26      this proceeding.        Consequently, should    we  fail to    obtain the rate 27      relief    requested here,    we  would have to immediately review our
 
construction program with      a  view toward reducing      it further. Should we  receive significantly less than the total          relief  requested,  our bonds could be downrated even        further  perhaps    to  a point'here    our ability to obtain capital    would be    totally restricted.      The nation's governmental and corporate debt        capital requirements are      such  that  A or lower rated long-term debt funds        will be  often unavailable at any price. I think it fair to    say  that should  we  not regain our A/A bond rating, or should    we  regain  it and fail to maintain it, our        ability to raise necessary capital      will be  impaired to the point that more 10    construction delays    will be    necessary. Should our bond    rating 11    deteriorate to    a Baa/BBB  the situation would      become most    perilous 12    and  substantial cutbacks in our construction program would immediately 13    follow. Should our rating drop          even lower than Baa/BBB, our      construction 14    pxogram would come    to  an immediate    halt  and mass  future shortages of 15    electrical  energy  in our service      area would be assured.      There  is  no 16 'ajor electric utility in        the United States which Moody's rates below 17    Baa. Thus, a reduction    in  CP&L's  rating to  Ba by Moody's would effectively eliminate the ability of          CP&L to raise funds in the capital 19    market.
20 Q. In past rate proceedings,      certain intervenors      have  insisted that rates 21    should not. be raised    in order to construct plants for future          use. Would 22    you please comment on    this position.
23 A. In requesting adequate rates,        we  are not requesting that today's rate-payer finance plants that    will be    used  in the future. What we-are 25    requesting  is that rates  be  set so that our present costs, including
 
the cost of a reasonable retuin on      capital,  be covered.    ,The  rates which  we are proposing are rates which are        fair based upon our pr'esent plant in service. No lesser rates would    be fair or adequate even if we  did not have  a  construction program.,    The reason our    construction requirements are emphasized      is that unless    our investors earn a      fair rate of return,  based upon    today's plant in service and today's level of costs, our credit rating      will not  permit us to borrow .the necessary 8    funds with which to continue construction        activities which    are
        '0 essential in order to have power      available in the future.
Q. Will you please briefly review your      Company's present    construction program.
11 A. Our  construction program, which is subject to continuing review, is 12    shown on  Harris Exhibit No. 2.      During 1975 our construction program 13    underwent substantial downward      revisions. It is now  tailored to the i~    amount  of capital which the    Company  reasonably hopes to    attract    assuming l =
15    appropriate rate    relief. Based upon present    construction plans      and the 16    Company's  revised load forecasts, the Company's generating reserve margin 17    will drop to  4.9 percent  in  1981, a negative 2.4 percent      in  1982 and a 18    negative .8 percent in 1983.      It will return    only to  a  positive 2.1 percent 19    in  1984.
20 Q. What  is the percentage  of reserve capacity which your        Company    is planning?
21 A. Up  until 1974 the Company had a goal      of  18  percent reserves.      This was 22    based upon reserve    levels  recommended  by the Federal Power Commission and 23    considered adequate by the Company.        However, during 1974      it became
:24    evident to the  Company  that  it would be unable to attract adequate capital 25    to provide these reserve    levels. It was therefore necessary to reduce
 
the level of planned reserves from 18 percent to 12 percent.                We  anti-cipate  no  difficulty in  meeting  this reserv'e criteria      thro'ugh the year 1980. As  pointed out in  my answer    to the previous question, however, the Company    will be  unable to provide even      this  minimum    level of reserves after  1980  if the          increases at the rate expected.
j  s 6    What  is the demand Company's demand    forecasts for the next        10 years?
7  A. We  expect demand to increase by 7.4 percent annually during the next 10 years. This compares with an annual increase at a compound rate of 10.4 percent over the 10 years ending in 1974.              It is    obvious that 10      the construction now planned by the Company is a minimum construction program which    will not maintain the Company's 12 percent reserve goal 12      in certain future years unless the growth in          demand    increases by no 13    more than an average      of 6.5 percent over the next        10  years.
14  Q. Could  it be  that your growth forecasts are in excess of what should 15    reasonably be expected?
16  A. Our  forecasts are based upon two studies          one conducted      within the 17    Company, and one conducted      by a  highly qualified outside consulting 18    firm,    Whereas,  in past years    we have    tended to approve a mid-range 19    of the upper and lower forecasts that have been proposed, our latest 20    approved forecast accepts      the lowest rate of growth suggested as 21    probable by the studies.        It would  certainly    seem  imprudent to ignore 22    what these studies tend      to show. In August of    1975 we had a peak 23    demand  of  5060 megawatts,    which  is in  excess  of the  5001 megawatts 24    we  were  projecting for 1975.      It is  the peak demand that determines the 25    amount  of capacity which    we must have    available.
 
1    e. What  growth are you experiencing        in  KWH  sales' 2    A. Our  sales growth    was  slower  in  1975 than expected although      with
: 3.      respect to certain classes of customers          it was  in line with our projections. As  I have  pointed out, our peak        demand  forecast did turn out to be conservative.
What" has been    your sales increase to date      in  1976'?
7    A. Through March of 1976, usage by our customers increased by almost 13%  over that of the    first  quarter of 1975;        Should  this continue, our 1976 sales forecast would prove overly conservative.
10 q. How has  your Company's load factor been affected by recent            kilowatt-ll      hour sales experience?
12 A. As peak demands    have continued to increase while          kilowatt-hour sales 13      remained    relatively flat, we have seen a natural deterioration in                  our 14      load  factor. This has not been in the interest of the ratepayer or'he 15  .        Company.
Would you please    describe your Company's future capital requirements.
17 A. Although our construction program has been reduced considerably, the 18      capital requirements remain      enormous.    $ 6.3  billion will be    required over the next 10 years.      $ 826  million is    necessary    for the years 20      1976-78, and a substantial portion of          this  must be raised through the 21      public sale of capital stock        and  first mortgage    bonds.
22            As a  result of inadequate earnings, the          Company's  last three 23      common  stock issues    had to  be  sold below book value.        This means that
 
37  percent of the  common  shares now outstanding has been sold below 2    book value and although there has been an improvement          in the price of 3    our stock as the stock market generally has improved,          it continues to sell below book value.      The  dilution in the value of    common  stock owned by  investors at the time of those sales has been substantial.
The Company must again    sell  common stock in the  fall of  this year.
Should these  applications not    be allowed  in their entirety,    and should the Company be forced to make refunds of amounts already collected,              we would not expect a successful        stock sale.
Mr. Harris,  one  of the three objectives of this rate case,'hich you mentioned at the beginning of your testimony, was that the Company be 12    able to continue normal maintenance.          Would you  elaborate on  this, please.
13 A. Yes. A part of the rate increase requested is to continue our normal maintenance program which we were able to        reinstitute after interim 15    retail  increases became effective      last fall. Normal maintenance 16    is  now underway pending    the outcome of this general rate request.
17    Unless  all  of the  relief  requested in this    fi.ling is  a11owed,  it wil1 18    be necessary    for  us again  to defer    some maintenance  expenditures.
Why  did your  Company  ever depart from what you term a "normal maintenance 20    program"?
21 A. ln  1974  it became  apparent that the rate    relief  sought  in applications 22    filed in  October 1973 would not be      sufficiently timely nor    adequate  to restore earnings to    a  level  where the Company's    securities would    be
 
attractive to investors      and could be  sold on reasonable terms.        Consequently, in order to preserve the      Company's  financial integrity      and  to  be able to continue to finance      its  construction program,    we went beyond    our on-going cost control program and inaugerated an emergency expense curtailment program, which was designed to delay or eliminate costs.              This program was  called to the Commission's attention during testimony in rate hearings in 1974. The program    eliminated  some  reasonable    and proper expenses and  deferred  some  essential expenditures pending        an improvement    in the 9 Company's  financial condition to      a point  .where  its  A bond  rating would 10 be  less insecure    and  it could  market  common  stock and other securities on  reasonable  terms. However, notwithstanding vigorous cost reduction 12 efforts the    Company's coverage    of fixed charges dropped below        2  times to 1.92 times at year      end 1974. In February 1975, the      Company's bond 14 rating  was reduced  from A to Baa by Moody's Investors Services, Inc.
15 and we have  not recovered    financially to    a point where delayed
                                                            'I and 16 badly needed expenditures can be resumed without further threat to 17 our  financial stability. In early        1975  it became    necessary  to further reduce our  level of maintenance to partially        compensate    for  revenues 19 lost  when  the North Carolina Commission restricted collections under 20 the fuel clause, and      for the further    purpose of attempting to raise 21 our earnings coverage of fixed charges to a level where we could continue 22 to market securities without having to pay exorbitant prices.                That 23 level of maintenance continued until our interim retail rate increases 24 were placed  into effect last year.
 
1 Q. To what do you    attribute your    Company's present      financial condition      and the fact that    it has  been unable .to earn the        rates of return allowed by  this Commission?
4 A. There are four major cost      factors,  all  of which are beyond our ability  to absorb or defer, that have led to our present depressed financial condition.      The  first  factor is    a  continuing high rate of inflation which affects electric utilities to            a  greater extent than industry generally.      Our present    rates,  as the Commission        is well  aware, were based upon costs      in a 1973  test year.
10            A second  factor which    I will mention and          a most  major  factor is the cost of capital.      The  cost of capital obtained on a long-term 12      basis has continued to increase.        The  $ 100  million in First      Mortgage 13      Bonds which we issued    in April of    1975 was    at  a  cost of 11.24%.
14      This compares to an average cost        for  bonds issued      in the former test year of 1973 of less than      8%. At the end of the      last test period, 16      the average interest rate      of, the  Company's    First  Mortgage Bonds was 17    ~
6.78%. By December    31, 1975  this  had increased      to  7 .72%. On  December 31, 18      1973  the average dividend rate on preferred stock was 7.24% on the 19      preferred stock outstandin    g. In March of    1975 we issued      preference 20      stock at  a  cost to the    Company  of 11.21%. As  I have  previously mentioned, 21    we  were unable to issue preferred stock          at this time because our earnings 22    were  insufficient to    meet the earnings coverage requirements              of our 23      charter. The average  dividend rate on preferred and preference stock 24      is now 8.06%,  having risen    11%  over the average dividend rate on 25    December 31, 1973.      The  cost of servicing    common    equity has 'also
 
increased    significantly    as we have been forced          to sell additional common    stock at below    its  book value.      En  our  last rate case,        I testified that in      November, 1973 we were required to              sell    3,000,000 shares of    common  stock at    a  "distressed price." That stock sold for
    '$21.25 per share, and netted to the            Company proceeds        of. $ 20.31 per share    after underwriting discounts.            Since that time,      we have    sold 4,000,000 shares of      common    stock "in January 1975 at        a  price of
    $ 14.75  per share,  31%  less than the      $ 21.25  per share      of,the November 1973    issue. The  net price was'nly        $ 14 .00 per share.
10  In October    1975 we  sold 5,000,000 shares of          cpmmon    stock at $17.'875 a  share,    23%  less than the      $ 23.34 book value.      The  net price      was only  $ 17.215 a share.
13        A  third factor    has been expenditures which we have made," and are continuing to    make  in increasing amounts, for environmental protection..
15  Since the beginning of 1972, we have invested over                  $ 84  million in 16  devices to protect -air and water.            We  are spending about        $ 30 million 17  annually for systems that do not add to our capacity                    indeed      many 18  use  substantial quantities of energy.              Consequently,      the cost    we 19  experience    is not limited to the cost of servicing the capital required 20  to install the systems and devices; our cost of producing electricity for sale increases since        a  portion of our gener'ation must            be used  to
: 22. operate    some  of the environmental devices.            We  simply cannot absorb
 
the tremendous costs involved .        When we  filed  our  last rate case, in October of 1973,      we  firmly believed that the cooling      system then planned    for the  Brunswick Nuclear Plant was not only adequate,          but was  acceptable to state and federal regulatory authorities.              Since that time,  we have been    ordered to    install cooling    towers at a cost of over  $ 72  million. We  are attempting to avoid      this requirement    as we feel that    it is  a  useless    expenditure of the Ielectric consumers money.
However,    it has  been necessary    for  us to  beginiconstruction of the cooling towers, and whatever costs are ultimately incurred            will have  to  be 10  recovered through increased rates.
ll        A  fourth major factor is attrition. Cost of building              power  plants 12 and  other  facilities    has increased    dramatically,    and as new  facilities are brought on      line  and  into the rate base,    it is  necessary  that costs associated    with  them be recovered .      The  cost of our Robinson Nuclear Unit completed in 1971        was about $ 127    per kilowatt capacity.      Our Brunswick No. 2  plant, which entered commercial operation in          November of last year cost about        $ 485  per kilowatt capacity.      While decreased 18  fuel costs associated with this nuclear plant            means  lower overall 19  rates to the consumer than would          be  possible with other forms of 2O  generation, the capital and other fixed costs associated with this n  generating plant have to be recovered through increased base rates.                  As 22  new and more    expensive    facilities  become a  part of the  Company's    rate 23  base, the    capital  and  other fixed costs associated with generating 24  electricity    increases accordingly.
 
What  action has your    Company    taken to reduce  its  expenses?
2 A. The Company    continues  a  vigorous cost control    earnings    improvement 3    program which eliminates or defers expenses          for items that are necessary 4    and  proper business expenses in the sense that they are desirable and 5    reasonable    but  are of the nature that they can be postponed          indefinitely 6    or delayed.      As a  part of  its  regular business practice the      Company 7    has always maintained a cost        control program in every department,        and the prevention of unnecessary        cost has always been    an  item of top priority with the Company's management. The commitment of the Company to "frugality" is well known to all who have ever been associated with ll    its operations. The expense curtailment program which is now in 12    effect,  however, goes beyond the Company's        tradition of austerity.
13    For instance, no new personnel may be employed without the            specific 14    approval of    me as  Chief Executive Officer.      I do  not approve the 15    filling of  any vacant    positions unless    it is  demonstrated    that the I
16    new employee    is absolutely essential in order to        assure that necessary 17    tasks can be carried    forth. Budget  restraints  have been imposed 18    on  all  departments. Moreoever,    we  have organized  within the 19    Company a  Corporate Performance Review Department.            Among  its 2O    duties is the responsibility of analyzing the performance of 21    the various facets of our Company's operation and comparing them 22    with those of other companies.        If other  companies are out-performing 23    CP&L  in  any area,  the responsibility of    this  Department    is to 24    determine why.      If any  other similarly situated    company  is doing efficiently        at less cost than this
                                                                                    '
25    anything more                  and                            Company, we
 
want  to  know about    it and  can  assure'he    Commission    that  we  wi11 implement any changes necessary        that might improve our performance 3        even  further.
4  Q. Is your corporate analysis far        enough along  to give any indication
'5        of  how  your  Company compares    with other similarly situated companies?
6  A. Yes  indeed.'ur total      operations compare most favorably with those of the industry generally      and  with eight similar southeastern investor-owned companies    with which  we have made    comparisons. For instance, the Company's    total operating    expenses  and  interest    charges per    kilowatt-hour of energy sold was less than        that experienced    by  six of the other 10'1.
seven comparison companies during the year 1974.            Stated another way,    we 12        delivered more kilowatt-hours per dollar of total operating expenses 13        and  interest  charges than did    all but one of the other comparison 14        companies. A  study of the 50 largest investor owned          electric utilities 15        in the country    shows  that while  CP&L was  28th from the largest customer 16        wise, in 1970, 26th in 1971,        and 25th  in  1972, its  operations and 17        maintenance  expenses    per kilowatt-hour sold were    "32d. from the highest 18        in 1970, 34th in    1971, and 39th from the highest      in  1972. Complete 19      ~
figures are unavailable for subsequent years at the present time; 20        however, we believe that the trend        is continuing.
21    Q. Are you  familiar with the recent      comparison study of      electric utilities 22        released by the National Association of Regulatory          Utility Commissioners?
23    A. Yes. Me  have received copies      of the report  and have analyzed      it. It confirms our    own  studies  and shows  that our  Company compares most 25        favorab1y" with other companies.      in every  area studied.
 
1 Q. Would you have any      objection to    a management  audit of your 4
Company 2    by an outside      consulting firm?
3 A. None  whatsoever.      I have  stated publicly    on any number  of occasions that  we  would welcome such an      audit. The  North Carolina General Assembly has  authorized the North Carolina        Utilities  Commission to order  audits once every  five years with the      expense being paid by the companies and recovered through rates.      The Commission has    recently  employed the  firm of  Booz, Allen and  Hamilton to conduct a review of our Company and            I would expect  this firm's findings to    be made  available to the South Carolina      Commission and  to the 10    public  . By  the time  we  have hearings    in these proceedings this review 11    should be well underway.        We  are confident that the audit    will reveal    that 12    we  are managing    efficiently.
Is your    Company  asking  for  a continuation of the fuel clause?
14 A. Yes. The  details of our    recommendations    are contained in the testimony of other witnesses.
Q. Do  you consider a      continuation of the fuel clause necessary in view of the fact prices have stabilized?
18 A. By  all  means. Fuel costs comprise such a large portion of our operating 19    expenses    that  even  slight fluctuations    amount  to tremendous  sums  of  money .
20    If the fluctuations      are downward the customers should receive the benefits.
21    If they are upward,      the  Company must    cover  its cost. Moreover,  we  are 22    sta.ll subject to immediate      and extreme upward    fluctuations in fuel prices 23    which cannot be accommodated        through  traditional  forms of rate hearings.
Finally, the introduction of larger percentages of nuclear generation                on 25    our system means that monthly costs of          fuel will vary significantly    even
 
if fuel  prices remain level.        This  is  because nuclear    fuel is  so, much less expensive than    fossil fuel. In        months when    we  get substantial
                                                                                          '1 nuclear generation fuel cost        will be  down. However,  in  months when nuclear plants are out for refueling or sub)ect to other outages fuel costs  will increase  appreciably.      We  are of the firm opinion that        a fuel ad)ustment clause is        a fair and  equitable  means  of compensating 7    for fuel cost fluctuations.
Q. Mr. Harris, would    you please    summarize your testimony.
9 A. My  testimony essentially is that notwithstanding rate              relief previously 10    granted by  this  Commission, the    level of earnings of the      Company    remain 11    significantly    below what the Commission has previously determined              fair 12    and  reasonable. This means that    CP6L  is not recovering all of its costs 13    and  its financial integrity is        continuing to decline.        In order to 14    continue our "bare bones" construction program,            it is  absolutely essential 15    that our  bond  rating  be  restored by Moody's at the earliest possible moment.
                                    '
16    For the bond    rating to  be  restored and maintained,      it will be    necessary    that 17    our coverage of fixed charges improve to a            level of at least    2  1/2 times 18    and be  maintained there    for    an appreciable    period of time.      Without rate 19    relief,  we would expect the amount and        quality of our earnings to decline 20    dramatically, especially        as new  plant  comes  into service.      Without rate 21    relief  which  we now  request, our bond rating        will be  sub)ect to further
                                                        /
22    deterioration    and  drastic cuts will have to        be made  in  what  is already 23    a  "bare bones" construction program.          Beyond any  question, unless      we  obtain 24    the rate  relief  requested    in this application, the      Company's    ability 25    to continue to provide service        efficiently to its    customers  will 26    ultimately suffer.
 
South Carolina Public Service Commission CAROLINA POWER & LIGHT COMPANY DIRECT TESTIMONY OF EDWARD G.        LILLY, JR.
1 'Q  Please    state your  name and  business address.
2 A. Edward G. Lilly, Jr.,  336 Fayetteville Street, Raleigh, Noith 3    Carolina.
4 Q. What  is your position with Carolina      Power &  Light  Company?
5 A. I am  Senior Vice President-Finance        of the  Company.
Q..Please describe your educational background            and business 7    experience.
A. I am  a  graduate of Davidson College where        I received  a  degree 9    of Bachelor of Science in Economics.          I hold  a Master of 10    Business Administration degree        in Banking  and Finance from the Wharton School    of Finance at the University of Pennsylvania.
12    I am  a  graduate of the Executive Program of the University of 13    North Carolina and      I have  completed the    Irving Trust  Company 14    Public    Utility Finance    Seminar. I am a member    of the Executive 15    Committee    of the Edison Electric Institute Finance Committee.
16            From 1952  to  1971  I was  associated with Wachovia Bank and 17    Trust    Company, where  I held  various positions which 'were related 18    principally to financial analysis, handling loans for corporate 19    customers and administration.        From 1963  to  1970  I served as 20    Senior Vice President and Office Executive of Wachovia's banks 21  . in the    Durham area. During 1970-1971    I  served as Manager of the
 
Investment Services Department at Wachovia's headquarters              in Winston-Salem. In  March 1971,    I became  associated with Carolina 3    Power &  Light  Company as    Senior Vice President-Finance.
4 Q. Please describe your duties as Senior Vice President-Finance                of 5    Carolina Power    & Light  Company.
A. I  am the senior financial      officer of the    Company and as such      I  am 7    responsible for the long-term        and  short-term financing programs 8    of the  Company. I have responsibility      for planning      and implement-ing the issuance,    sale and servicing of      first mortgage    bonds, 10    preferred stock,    common  stock and any other securities issued by the Company, as well as short-term financing arrangements              of the 12    Company  including the negotiation of bank loans          an'd  commercial 4
13    paper. In addition,    I am  responsible for developing        and maintain-14    ing the Company's investor relations program with the financial 15    community. I have overall responsibility for          the treasury, 16    accounting, computer services, purchasing and internal auditing 17    functions of the    Company,    including preparation of budgets        and 18    forecasts  and  all financial    statements    issued by the Company.        My 19    responsibility also includes the        management    of  Company funds    to 20    insure that the    Company has    available at    all  times    sufficient  cash 21    to pay its expenses of operation        and to meet    its  payments  for con-22    struction work.
Please state the nature and scope of the testimony which you                will 24    offer.
25 A. This testimony    will relate    to the Company's financing plans which 26    must be implemented    in order to obtain the funds necessary to            meet
 
the tremendous challenge facing the          Company  of constructing sufficient generating      and  other necessary      facilities to    meet the needs  of our customers    and  to the problems facing the        Company  in 4    the undertaking of this financing.
Q. Will you please explain the        Company's    financing plans?
A. Despite the emphasis on energy conservation which has been stressed 7    by the Company    for several years,'he electric energy            demands  of 8    our service area continue to grow to such an extent that the 9    Company's planned    construction expenditures for the next            10 'years 10    will amount    to approximately      $ 6.3  billion. In    the  first  quarter of this year, energy      demand  rose    13 percent over the    same  period 12    last year. We  anticipate that approximately        $ 4.0  billion of this 13    amount must be financed through the          attraction of    new  capital to 14    the Company from the sale of securities in the financial market, 15    an amount unprecedented      in the history of Carolina        Power &  Light 16    Company. The impact    of this program is brought into focus by 17    comparing the  additional    $ 6.3  billion plant investment with the 18    Company's net    plant account      of $ 2.2 billion at year end 1975.
19    Looking to the immediate future, the Company's construction expendi-20    tures for the years    1976  through 1978 are expected to amount to 21    $ 826,000,000.
22          In order to finance this three-year construction program, the 23    Company must  raise  a  substantial portion of the        $ 826,000,000    by 24    the attraction of additional capital to the Company.              These funds 25    can be obtained only through the sale          of the Company's    securities 26    to willing investors in the        open market. The Company now has
 
~  1    about 91,000 shareholders.        Over 39,000    of them, or approximately 43%, are  located in the Carolinas.        We  cannot expect investors to continue to invest their savings in our          Company  unless    we can  earn'n adequate  rate of return    on such investment and      provide satis-5    factory dividends.
6 Q. How does  the Company plan to secure funds to meet          its construction 7    program  for the years    1976-19782 8 A. A  portion of the required funds      will come  from retained earnings, charges to depreciation and deferred income taxes.              However,    a        major 10    portion of the funds must      be obtained by the sale        of additional securities of the    Company. We  must  sell  new  securities in sub-12    stantial  amounts each year.
13          A  brief review of the securities offered to the public by th' 14    Company during 1975 illustrates the cost penalties which must be 15    borne by the Company and      its  customers as    a  result of    an unsatis-16    factory financial condition.
17          During January 1975,      it was  necessary    for the  Company    to sell 18    common  stock in order to attract capital and to improve the              common 19    equity ratio of the    Company  which had    fallen to  a  low  level of 20    less than  30%. The Company    sold 4,000,000 shares of      common  stock 21    which resulted in    a  net'rice    to the  Company    of only  $ 14 per share, 22    which was approximately      60%  of the book value of the        common  stock 23    at the time of the sale.      Obviously, such    a  sale of  common  equity 24    is extremely unsatisfactory      and  substantially dilutes the value of 25    the shares of    common  stock previously held by the Company's share-26    holders.
 
During March 1975, the Company would      like to    have sold  preferred stock. However, because    of the continued decline in earnings avail-able  for interest  and preferred dividends, the coverage ratio for interest'ayments      and preferred stock dividends had been reduced to the level where the Company did not meet        its  required Charter test
  'to market preferred stock.      Thus,  it was  necessary    for the  Company    to sell preference stock,    a  junior security to preferred stock, in order to attract needed capital.      Since the preference stock was basically unattractive to institutional investors,        it was  necessary    to offer 10  the stock at    a  925.00 issue price, as opposed to the      $ 100.00  issue price which had previously been used by the        Company  for distribution 12  of preferred stock, thus substantially increasing the distribution cost. The  net cost to the  Company  for the funds obtained through 14  the sale of preference stock was 11.17%, the highest rate ever paid 15  by the Company on preferred or preference        stock.
16        During April 1975, the    Company  offered  $ 100,000,000    of first  '7 mortgage bonds.      Since the Company was  utilizing    the fund's to finance 18  generating and other long-life equipment installed for the benefit 19  of  its  customers,  the Company wished to    sell  bonds  with  a  maturity 20  of  30  years. However, as a  result of the  bond  rating of the    Company 21  having been reduced from      A to Baa by Moody's    Investors Service, 22  because  of the unsatisfactory earnings of the        Company  resulting in fixed charge coverage of less than 2.0 times,          it was  not possible 24  for the .underwriters to market 30-year      bonds on any    satisfactory 25  basis. Thus, the  maturity of the  bonds had to be reduced to nine 26  years and sold at    a net cost to the  Company  of  11.24%. This cost
 
was the  highest cost the      Company had    ever experie'need      in  connec-tion with its    first mortgage bonds.
During  the fall of 1975, the common        equity ratio of the        Company was again  at  an  extremely low level of less than          30% and    thus  it was necessary    for the  Company    again to  sell  common    stock in order to attract capital    and improve the common      equity, ratio.      The Company 7    sold 5,000,000 shares of        common  stock during'October 1975 at          a  net 8    price to the    Company  of 917.215 per share or approximately            75%  of 9 'ook value.        Again, this sale of      common  stock resulted in additional 10    substantial dilution to the present shareholders of the                  Company.
During the years 1976-1978, the Company            will need    to sell sub-12    stantial additional      amounts    of securities.      The exact    timing  and 13    types of securities sold        will be  influenced by the      ability of    the 14    Company  to meet coverage      ratio tests    and  maintain    a  reasonable    capital 15    structure,  as  well  as the    conditions of the securities markets during 16    those years.      One  of the major problems facing        the, Company    is the 17    need  for continued sales of large        amounts  of  common    stock, which the 18    Company needs    to sell at prices above book value.
19 Q. What,  if any,  other problems    do you  feel the    Company    faces  in 20    carrying. out this financing program?
21 A. Historically, the      Company has    raised capital for      its construction 22    program through the sale        of  first mortgage    bonds, preferred stock 23    and common  stock. Let  me  examine  briefly  the current situation 24    relative to the    Company's    ability  to issue such types of securities.
25    First  Mort  a e  Bonds 26          Table  I listed  below shows the average cost of outstanding
 
bonds at the end    of  each  of the past ten years      and  at June 30, 1975. As  recently  as December 31, 1969, the average          cost of 3, all  bonds outstanding was 4.72%.          This, average cost    has increased with the sale of    each issue    of bonds by the    Company and had reached 7.72% by year end 1975, an increase of            63%  during the six-year period.
TABLE  I 8                                                        End of Year Embedded Cost Year                                            All Bonds 10        1966                                              4.04 1967                                              4.40 12        1968                                              4.72 13        1969                                              4.72 14        1970                                              5.64 15        1971                                              6.14 1972                                              .6.40 17        1973                                              6.77 18        1974                                              7;29 19        1975                                              7.72 20        The  ability of    the Company to acquire capital through the 21  sale of  first mortgage    bonds  at a  competitive interest rate is 22  principally determined      by the  rating which the    first mortgage 23  bonds  of the  Company are assigned      by the major bond    rating 24  agencies. As a result of declining earnings        and thus    declining 25  fixed charge coverage ratios, the          first mortgage    bonds  of the 26  Company were downrated        during  1971 by  both of the major rating
 
agencies  from  AA  to A. Fixed charge coverage ratios declined further during    1973 and 1974 and by December    1974 had dropped to the dangerously low level of 1.92 times.          Moody's reduced first mortgage h
4  the rating on the Company's                        bonds    to Baa, further aggravating the    ability of  the Company to raise needed capital.
During the second      half of  1975,  principally    as a    result of the addition of revenues collected, subject to refund, under South Carolina and North Carolina        interim rate increase orders          and a wholesale rate increase order from the Federal Power Commission, 10  the Company's fixed charge coverage improved        slightly to        2.27 times by year end 1975.      However, we    feel  it absolutely    necessary    for the fixed charge coverage      ratio to increase to    a  minimum    of 2.5 times 13  and to remain somewhat above that level in order for the                Company 14  to retain  its  A bond  rating  and  to hold such  a bond      rating.
Table  II lists    the year end fixed charge coverage          ratios of 16  the Company, as calculated under the Securities          6  Exchange formula, 17 . for the past    10  years.
18                          TABLE  II
.19      Year  "
Fixed Char      e  Covera e Ratio 20        1966                                                      5.16 21        1967                                                      4.87 22      1968                                                        4.32 23      1969                                                        3.38 24      1970                                                      .2. 25 25      1971                                                        2.50 26      1972                                                        2.90, 27      1973                                                        2.34 28      1974                                                        1.92 29      1975                                                        2.27
                                -  8-
 
As shown,    as  recently  as December '31, 1972,      the fixed charge coverage    ratio  was 2.90    times, but had declined to 1.92 times            as of  December 31, 1974, a      decline to  a dangerously low level.          While the collection of "subject to refund" revenues allowed under interim rate orders    and the    receipt of  a  rate order making permanent          all revenues collected on North Carolina          retail    sales has resulted in an improvement      in fixed charge coverage during recent months,              as  of the time of the preparation of this testimony, the                Company  still has    not received    a  restoration of its    A bond  rating from      Moody's Investors 10      Service.      If the  coverage  of fixed charges    does not continue      to 11      improve    in the near future, the      Company    risks not only    a  continuation 12      of the  Baa  rating assigned by Moody's, but        a  downgrading    of the    A 13      rating presently assigned        by the other major bond      rating    agency.
14  Q. What  effect  has the    reduction of the rating on the Company's bonds 15      from A/A to Baa/A had upon the Companyf          ~
A. T1ie  reduction of the rating      on the Company's      first mortgage    bonds 17      to Baa/A has had three major negative effects upon the                Company.
18      First,  the reduction in rating requires that the Company pay                a 19      substantially higher cost in order to sell its bonds.                In his 20      testimony, Mr. Shearon Harris has pointed out that in April 1975, 21'2    after the    downgrading of CP&L's bonds, the Company sold            $ 100,000,000 first mortgage    bonds at a cost    to the  Company    of  11.24%. The  next 23      sale of  a  comparable size issue with      a  comparable maturity by an 24      electric    utility company      with an A/A  rating occurred      a short time 25      later  when  Florida    Power &  Light  Company    sold  $ 100,000,000    of  first 26      mortgage bonds at      a  cost of 9.08%, 216 basis points lower than the
 
cost  CP&L was    required to pay.        While the difference in cost between    a Baa/A bond and an A/A bond          will vary, it is    expected that the cost differential generally            will be high.
Since CP&L    utilizes    most  of the  funds obtained from the sale of  first mortgage      bonds  to pay for assets with      an expected    life of  25  years or longer,      it has  been the    practice of the    Company  to sell  bonds  with    a  maturity of    30  years. Unfortunately, the    CP&L
                                      'I bond  rating of    Baa/A was not      sufficiently high to attract investors to  a  30-year maturity at the time of the 'last bond sale and thus 10 it was  necessary      for the  Company  to sell bonds with    a  maturity of only nine years.        Such  action, 'of course, indicates that the risk 12 of additional financing          and the expense    of additional financing 13 must be met during the expected            life of  the assets.
14        Second,  a  reduction in bond rating has eliminated certain sources 15 of funds to the      Company;    that is,  many  institutional investors and 16 large individual investors          as a  matter of policy or of legal limita-17 tion will not      purchase    a  bond  with  a  rating below A/A. For      example, 18 pension funds      for the    employees    of the States of South Carolina        and 19 North Carolina may no longer be invested in bonds presently being 20 offered by    CP&L. Such  restrictions of the      market  in which the 21 bonds  of the  Company    are sold increase greatly the        difficulty of 22 marketing the Company's bonds at any reasonable              interest rate.
23        Third, the reduction from the A/A rating of the Company's bonds also has had    a  substantial adverse impact        upon other    financing costs 25 of the  Company.      At the time Hoody's reduced the Company's bond 26 rating,    it also    reduced from    A to  Baa  the rating on the Company's lo-
 
preferred stock    and reduced    the rating on the Company's commercial paper from Prime    1  to Prime 2. The Prime 2 c'ommercial paper      rating has  resulted in the Company's cost for these short-term borrowings increasing by    50  to  75  basis points.      (i.e.,  6.00%  to 6.50% or 6.75%). The  rating assigned to      a  Company's  first mortgage  bonds is in effect the "key rating" to which other securities              and borrowings
      ~
of the  Company  are related.      The    fact that  CP6L's  securities are  now rated below investment grade has had          a  substantial adverse impact upon the cost    of long-term    and  short-term securities'ssued        by the 10      Company,  as  well  as any lease    financing or other types of financing which the Company may      utilize.
12      Preferred Stock 13 Q. Please comment upon the      difficulty, if any, of selling        preferred I
14      stock.
15 A. Table  III lists    the average cost of preferred stock of the          Company 16      at the  end  of each  of the past    10  years.
17                              TABLE  III Weighted 18            Year 19            1966                                              4.72, 20            1967                                              5.06 21            1968                                              5.06 22            1969                                              5.06 23            1970                                              6.46 24            1971                                              6.91 1972                                              7.17 26            1973                                              7. 24 27            1974                                              7.54 28            1975                                              8.06
 
Here again,    it is    noted that as recently as December 31, 1969, the average cost          of preferred stock    was 5.06%. As  of December 31, 1975,        this cost    had increased    to 8.06%,    an increase of  59%. As was    discussed    earlier, during    most of 1975, the Company, because      of reduced earnings available to          pay    interest and  preferred stock dividends, did not meet          its  Charter require-ments  for the issuance of additional preferred stock.                Thus, the Company  simply was in      a  position    where  it could  not issue preferred stock and had to resort to other, more expensive,              sources of 10 capital. In  March 1975      it was  necessary  for the  Company    to issue preference stock,      a  class of stock rated junior to preferred stock,-.
12 at  a  cost to the    Company    of  11.17%. The cost of issuing preferred 13 or preference stocks with ratings .lower than A/A was quite high 14 during 1975.      For example, during September 1975, Indiana Michigan 15 Electric  Company    sold an issue of preferred stock with            a rating of 16 Baa/BBB  at  a  cost to the      Company    of 12.75%. It is    noted that the 17 rating obtained by Indiana Michigan Electric              Company was above      the
                                                                  'I 18 rating which could        have been obtained on CP&L reference            stock.
19 Since preference      stock is      a junior issue to referred stock, the 20 rating agencies normally assign            a  rating to preference stock      one 21 rating below the rating assigned to preferred stock.
22        Again, the collection of additional revenues,              which are subject 23 to refund    as aLlowed by      interim rate increases, has allowed the Company's earnings        to improve sufficiently to meet the Company's 25 Charter requirements        for'he    issuance of preferred stock provided 26 such revenues    are made permanent by the appropriate regulatory 27 authorities.
12-
 
Common  Stock 2, Q. Please comment upon the common equity          ratio of    the Company.
3  A. It  is vitally important that the        Company, be  able to    sell  common stock successfully.      Common  stock is the foundation upon which senior capital financing      rests.. The bond  holder    -and  other senior capital holders look to      an adequate  common    stock equity base for protection of "their investments.        Thus, the common equity          ratio of the  Company    is extremely important in determining the              Company's continued    ability  to sell senior securities.        The goal      of the 10      Company  is  a common  equity ratio of approximately          35%. The  long-term financing plans of the Company are designed to achieve                  this 12      goal. However,    after the sale of    two issues    of  common    stock 13      totaling 9,000,000      shares during 1975, the common equity            ratio of the Company is less than      33% and  thus the Company      will need    to sell 15      additional    common  equity in the near future.        While general financial 16      market conditions have improved and the market price of                CP&L common 17      stock has also improved, the stock of the          Company    still has    a 18      market price below book value.
19  Q. Does the Company experience      any  significant difficulties in attract-20      ing  common  equity?
21  A. During 1965, the    common  stock of  CP&L  sold at  $ 52  per share.      During 22      late  1974, the common stock      of the  Company    sold below    $ 11  per share 23      or at less than    50%  of book value. Table IV shows the relationship
: 24. of the sales price of      common  stock to the book value per share for 25      the  last four sales of    common  equity by the    Company.
 
TABLE  IV Percentage
                                                                                ~ Above or Date of            Number          Net Price            Book          Below Book Sale            of  Shares        Per Share          Value              Value ll/9/72            2,500,000            28.05            21.16              32.6 11/15/73          30000,000            20.31            23.25              (12.6) 1/16/75            4,000,000            14.00            ,.23. 35            (40. 0)
      .10/28/75          5,000,000            17.215                              (25.6)
The  rapid  and sharp  reduction from the    ability to sell      common equity at more than book value to the necessity to sell at prices 10    substantially under      book value  is having  a severe impact upon the ability of    the  Company  to attract  common  equity    on any reasonable 12    .basis.
13            When  the stock of    a company  is selling below      book value,    a 14    greater    number  of shares is required to      be issued    in order to obtain 15    a  given amount of equity capital.          This action results in additional 16    dilution in the existing shareholder's equity            and a    dilution in his 17    future earnings per share.        Such  action further depresses        the market 18    price of the existing stock, thereby increasing the cost of equity 19    and debt    financing to the    Company and making    it 'even    more difficult 20    for  a  company  to finance  on any reasonable    basis.
21 Q. Are there other      factors which  add  to the  difficulty which the Company 22    experiences    in raising the funds      necessary to meet its construction 23    responsibilities?
24 A. Yes, the substantial percentage        of earnings of the        Company .which 25    result from allowance for funds        used during  construction has had        a 26    serious adverse impact upon the securities of the              Company  in the
 
financial markets.      Table  V  lists  the amount and percentage              of net income  available for    common  stock that is composed of allowance for funds  used during    construction for the years        ended December 31, 1969 through December 31, 1975.
TABLE V Allowance For Funds Net Income          Allowance For        Used During Construction After Preferred      Funds Used During                  As % of Net Income 7  12 Months Ended
* 1969        24,418,000            4,397,000            "'ecember 18.0 9  December 1970          20,126,000            10,505,000                            52.2 10 .December  1971        29,103,000            14,708,000                          50.5 December  1972        50,917,000            24,759,000,                          48.6 12  December 1973          52,982,000            38,093,000                          71.9 13  December 1974          51,599,000            54,609,000                          105.8 14  December 1975          75,870,000            59,957,000                          79.0 15  Q. Please explain the changes        in this percentage    and  the significance 16      of these  changes  to the  Company.
A. During the year 1969, only      18%  of the net    income  available for          common 18      stock  was a  result of allowance for        funds used during construction.
19      This percentage    increased rapidly to      a  level of approximately            50%
20      during the period    1970 through 1972.        During the years 1973 through 21      1975, the percentage      again increased sharply averaging approximately 85%  during the most recent three years.          It  is noted that during the year 1974, allowance for funds used during construction actually 24      exceeded  net .income available for      common  stock. Regardless          of the 25      current accounting treatment of allowance for funds used during 26      construction  as  "nonoperating income," the amounts are not revenues
                                  - 15
 
received from the sale of        electricity. When  allowance  for  funds used during    construction is excluded from the calculation for fixed charge coverages,        the  ratio for    the year ended December 1975 drops from 2.27 times        to an alarming level of 1.67 times.
This situation results from the large amount of construction work  in progress    upon which the Company      realizes  no cash earnings.
On  average during 1975, construction work inprogress amounted to
      $ 886,000,000    or approximately      75% of net plant in service.        Thus, for every dollar of net investment of plant in service, the 10    Company had    approximately    75C  invested in construction work in progress upon which        it did  not receive any cash earnings.        Mitchell, 12    Hutchins, inc.,      a  highly regarded research firm in the financial 13    community, conducted a study          of 45 major  electric  utility companies 14    during April 1975.        This study shows    CP&L as  the only company where 15    allowance    for funds    exceeded    net income for    common  stock during the
'16    year 1974.      Such a  condition obviously causes grave concern in the 17    minds  of investors    as  to the financial soundness of      a  company.
1 18 g. Mr. Lilly, please summarize the factors,to which you              have  testified 19    which cause difficulty in attracting capital to meet              the Company's 20    construction expenditures.
21 A. ~e  financial condition of the        Company  deteriorated rapidly during 22    1974 and 1975.      Fixed charge coverage      fell  to extremely low levels.
23    resulting in    a  reduction in the ratings of the Company's          first 24    mortgage bonds, preferred stock and commercial paper.                The percentage 25    of net  income    available for    common  stock represented by allowance 26    for funds    used during    construction  h'as  increased rapidly and during
 
1974 allowance    for funds  used during    construction actually exceeded total,net  income  available for    common  stock. The  cost of attracting capital to the    Company has    continued 'to increase and remains at      a high level.
These  factors,  when combined    with  a return  on common equity of an amount  less than the earnings level which this Commission has previously found to    be  fair  and  reasonable,    have  resulted in the necessity of the    Company  selling additional      common  stock at prices below book value.      The  selling of    common  stock below book 'value further aggravates the serious financial condition of the            Company.
Without the interim rate increases ordered by this Commission and  other regulatory jurisdictions, the Company's financial condition continues to be    critical.
The approval    of the requested rates      so as  to allow the  Company to restore  its  coverage  of fixed charges    and  preferred dividends and  to earn  a reasonable  return  on  equity capital is absolutely essential in order for the      Company  to continue to finance    its operations  and  to provide adequate      and dependable    service to  its customers'7-
 
South Carolina Public Service Commission Docket Nos. 18,361 and 18,387 CAROLINA POWER & LIGHT COMPANY TESTIMONY OF PAUL S. BRADSHAW 1 Q. Please state your name and business        address.
2 A. Paul S. Bradshaw, 336 Fayetteville Street, Raleigh, North Carolina.
3 Q. What  is your occupation?
4  A. Assistant'Treasurer    in  charge of the Budgets and      Statistics Section 5    of the Treasury    and Accounting Department      of Carolina  Power &  Light 6    Company.
7 Q. Please describe your educational background and business experience.
8 A. I  attended Southeastern University and graduated from the Accounting 9    School'of that University with        a Master's Degree in Accounting.
10    Immediately  prior to joining Carolina      Power &    Light Company    in July, 11    1962,  I worked  for the Washington Gas Light Company, a natural gas 12    utility, in Washington,      D. C. I .am a member    of the Finance Section 13    of the Southeastern Electric      Exchange and also a member      of the 14    Budgeting Committee of the Edison Electr'ic        Institute. I have completed 15    the Public  Utility Executive    course at the    Georgia Institute of 16    Technology.
17  Q. What are your    duties with Carolina Power      &  Light  Company?
18  A. I have  been responsible    for the operation of the      Budgets and    Statistics 19    Section since    its  formation in 1972. I  am  responsible for the 20    Budget  Unit, Statistical Unit    and  Financial Analysis.      Prior to 21    formation of the Budgets and Statistics Section,          I was  Assistant 22    Controller in charge of General Accounting.
23  Q. Please examine    this  document, marked "Bradshaw      Exhibit  No. 1,"
24    consistingof twelvepages,      and  state whether or not    it was  prepared 25    under your supervision and direction.
 
1  A. Yes,  it was.  (Identify) 2  Q. Will you describe this      exhib5.t?
3  A. This exhibit sets out, the balance sheet of the          Company as  of 4      December 31, 1975, and statements        of income    and  retained earnings 5      of the  Company  for the twelve    months which ended December 31, 1975. -'
It contains    notes which are an integral part of the statements.
7    This exhibit 'is the    same as  Exhibit  I  filed with  the Commission 8      in. the series of exhibits containing        data  for the test period 9,    consisting of the calendar year 1975.
10  Q. Will you please    examine  this  document, marked "Bradshaw        Exhibit  No. 2,"
and  state whether or not    it was  prepared under your supervision and 12      direction7 13  A: Yes,  it was.    (Identify) 14  Q. Please describe    this exhibit.
15  A. This exhibit sets forth the original cost of the electric              utility 16      plant in service of our      Company as shown on      our books and records 17      at  December 31, 1975.      After deducting    $ 18,507,102,  representing 18      the accumulated provision      for amortization of nuclear fuel, the 19      total  amount  of plant in service    and  nuclear fuel is    $ 1,888,955,553.
20      The  plant in service is subdivided into functional accounts.              Of 21      course, the nuclear fuel is related only to the production function.
22      This exhibit is the    same as  Exhibit  C  in the exhibits filed with 23      the Commission.
24  Q. Will you please    examine  this  document, marked "Bradshaw        Exhibit  No. 3,"
25      and  state whether or not    it was  prepared under your supervision and 26      direction,  and  state what is    shown on    this exhibit2
 
I A. Bradshaw  Exhibit  No. 3," which  is the  same as  Exhibit  D  filed for the test period 1975, was prepared under        my  supervision    and direction  and  states the amounts of the accumulated provision for depreciation of plant in service      as shown on the books        at 31, 1975. The amounts have been adjusted      to reflect'ecember depreciation for    a full year  on plant in service at that date.
7      The amounts are shown by    functional accounts corresponding to 8      the functional accounts under plant      in service    on my  Exhibit        No. 2.
9  Q. Will you please state    whether or not Bradshaw Exhibit No.          4 was 10    prepared by you or under your supervision?
ll  A. Yes,  it was.L (Identify) 12  Q. Will you please describe this exhibit?
13  A. This exhibit shows the Company's operating        revenues    and  operating 14      expenses  by major categories    for the calendar year      1975.
15  Q. Have you made any accounting and proforma adjustments            to the test 16      year?
17  A. Yes. The adjustments    made  to the test year are summarized in 18      Bradshaw  Exhibit  No. 5.
19  Q. Would you please    explain these adjustments?
20  A. Yes. Adjustment No. 1 was  necessary  to correct insurance expense 21      for the test year. Insurance expense applicable to the Brunswick 22      No. 2  unit in  November and December 1975 was        inadvertently charged 23      to plant account and should have been charged to expense.                  This 24      adjustment charges expense      in the  amount  of $ 109,024.
25            Adjustment No. 2  is necessary'to charge-off one-fifth of the 26      cost of abandoning the Craven County Plant site.          The  five-year
 
write-off was    ordered by this Commission.
Il Adjustment No. 3  is to normalize the effect of hydro generation for the test year.      The    value of hydro generation in the test year was  adjusted to the 45-year average hydro generation resulting in a charge to Expense of      $ 1, 168, 558.
Adjustment No. 4    is to reflect      wages  for the test year    based on the year-end      level. This requires        an increase  in operating expenses    of $ 4,560,087    and a    related increase in payroll taxes of
    $ 234,822.
10          Adjustment No. 5  is necessary to reflect in the test year the effect of    a  postage increase that was placed        in effect  December 28, 12  1975. The  effect  on operating expenses      would be an increase of 13  $ 293,331.
Adjustment Nos. 6,      7 and 8  are to increase maintenance expense 15  for the test year to      a more    normal  level. During    1975, because    of 16 . low earnings and coverage,          the Company was operating under      a  program 17  of reduced expenses in          all  areas possible. The  expenses'hat    were deferred or eliminated in          1975 must be resumed    in the future.
During  a normal operating year, additional maintenance            expenses    in 20  the amount of $ 5,217,000 would be required.            The amount  deferred in 21  each category was      production - $ 507,000; transmission - $ 710,000; 22  and,  distribution - $ 4,000,000.
23          Adjustment No. 9.was made to adjust depreciation expense to 24  the level of plant in service at year-end and also to compensate 25  for  a change    in depreciation rates.        The change  in depreciation 26  rates is the result of        a  study  made by Ebasco  Services, Incorporated,
 
and  will be testified    to in this case by Mr. Reilly.
Adjustment No. 10    is necessary to      compensate  for  an increase in Social Security taxes.        The PICA  taxable  wage base was increased from $ 14,100 to      $ 15,300  thus necessitating      an increase'o the test year tax expense of $ 57,508.
Adjustment No. 11 relates the property taxes to the year'end level of Plant in Service at the        end  of the test year.      To adjust the property tax expense to the year-end level of Plant, in Service required    an increase    in pioperty tax      expense            of 10    $ 4,091,032.
Adjustment No. 12 is necessary        to achieve comprehensive 12    interperiod allocation of      income taxes.      The adjustment    in the amount of $ 15,614,000 to deferred taxes in the test year accomplishes    full normalization    of deferred taxes.
15 Q. Will you state    whether or not the Company maintains bank balances 16    as a  part of its  commitment    in connection with loans obtained 17    from banking    institutions.
18 A. Yes.
19 Q. What was the amount    of  such bank balances      supporting loan 20    commitments  at  December 31, 1975.
21 A. The amount  of  such balances    then was  $ 9,350,000. These funds 22    are not maintained to support normal bank accounting services 23    such'as checking and collection of funds deposited, but are 24    specifically required in connection with credit extension.
25 Q. Is the  Company  requesting any change in        its  treatment of deferred 26    fuel cost in this proceeding?
 
1 A. Yes,  it is. The Company has been    deferring the expensing of 2    increased fuel costs on      its  books  until  the month in which 3    related revenues are billed.        However, beginning    with the effective date of the      new  fuel clause  proposed  in this proceeding,    we  will no  longer use deferral accounting for fuel  expenses. At that time  all fuel  costs  will be                expensed on a  current basis. When  the new fuel clause goes into effect the    books  of the  Company  will contain    two months'dditional fuel cost that    must be  collected from the customers.
10    This  is fuel costs for the prior      two months    in excess                of the base cost. This fuel has been used      in serving the                  customers 12    and must. be paid    for by the customers.      Without collecting 13    revenues  to cover these deferred fuel costs, the          Company                will be 14    unfairly penalized    and earnings    will be  adversely affected.
15 Q. .How  do you propose to    collect this deferred fuel      expense                from the 16    customers?
17 A. We  propose to    collect the deferred fuel      expense by a temporary 18    charge on the customer's      bill for a  period of approximately 19    12 months. The amount  of the temporary charge      will be                determined 20    by the amount of deferred      fuel  expense  attributed to                  South Carolina 21    retail  sales at the time the new rates are placed in effect.                          This 22    amount could be    collected in  a  shorter time period, but                    we 23    believe  12 months  is a  fair  and reasonable    time period.                  Assuming 24    the new rates are placed      in effect  September    1, 1976, the charge
 
will be  .072 cents per 15lH based on the  fuel cost deferred in July  and August. This will be billed  on Temporary Rider No. 40, which  is attached as Bradshaw  Exhibit No. 6. A copy of this Rider is also included in the Exhibit which presents the alternate rates that the  Company is .requesting in this proceeding.
 
South Carolina Public Service Commission CAROLINA POWER    & LIGHT  COMPANY TESTIMONY OF JOHN    J. REILLY 1 Q. Will you state your    name and  address?
2 A. My name  is  John J. Reilly,  and my place    of residence is Glen Cove, Long  Island,  a  suburb of    New York City.
4 Q. What  is your occupation,    Mr. Reilly?
5 A. I  am a professional engineer employed by        Ebasco Services Incorporated at 100 Church Street,        New  York City, and hold the position of Consulting Engineer.
8 Q. What  kind of organization is Ebasco Services?
9 A. Ebasco has provided    engineering, design, construction and 10    management  consulting services to public        utilities,  other industries  and governments    for the past    70  years. It is  one 12    of the foremost designers      and  constructors of power plants in 13    the world.
14 Q. Will you  summarize  briefly your    education and professional 15    experience?
16 A., I am a  graduate of Ohio University with a degree of Bachelor 17    of Science in Civil Engineering in the year 1932.            I  also 18    completed graduate courses      in  Power  Plant Engineering at 19    Columbia  University during    1939 and 1940.      During the period 20    1933-1937,  I worked for  the City of    New  York as Structural 21    Design  Engineer. I was    employed by Ebasco Services        Incorporated 22    as a Design Engineer    in April .1937. Since 1937, except    for  a
 
two-year period of service in 'the Navy,        I have    been continuously employed by Ebasco.        During the ma)or part of the 37-year period I have    been engaged  in engineering work closely related to the appraisal of industrial property.          These  appraisal studies were made  generally for acquisition sale, financing, rate condemnation and  tax purposes, or to satisfy the requirements of local, State and  Federal regulatory agencies.      During this 37-year period,        I assisted with appraisal studies for        some 200    industrial    and government    clients,  more than  half of  which were public      utility 10    clients.      During  this  same  period  I either    made  or directed approximately 125 depreciation studies for            some 55  public  utility 12    clients. In connection with these appraisal or depreciation
.13    studies,    I participated in    conferences,    or hearings, as    a
'4      consultant, or expert witness, in proceedings before the following 15    regulatory agencies:
16            Florida, Idaho, Indiana, Kansas, Massachusetts,            Nevada, 17            New  Mexico,  New  York, North Carolina, Ohio, Pennsylvania, 18            Rhode Island, South Carolina, Virginia, Washington, 19            State Public Utilities Commission, 20            Federal Maritime Commission, 21            Federal Power Commission, 22            Department of Justice and 23            Internal  Revenue  Service.
24            I have  also appeared as an expert valuation          and  depreciation 25    witness before Courts of law in the United States and Canada.
26 Q. I- show 'you  a document    consisting of seven pages entitled Depre-27    ciation Studies involving Statistical          Methods Made    for Public 28    Utility Clients    and ask you  if that  is  a  list of  public  utility 29    clients for    whom  you have made depreciation studies?
 
1 A. Yes  it is.
2 Q. Are you  a  Licensed Professional Engineer?
3 A. Yes,  I am a  registered Professional Engineer in the states of 4    Indiana, Louisiana,    New  York, Pennsylvania,    Rhode  Island, Virginia,  Texas, and Washington.      .I also hold  a  certificate of qualification issued by the National Bureau of Engineering Registration.
8 Q. Are you a member of any professional societies?
9 A. Yes,  I am a member    of the American Society of Appraisers      and 10    the American Society of      Civil Engineers    and formerly  a member 11    of the Depreciation Accounting      Committee of the Edison    Electric 12    Institute  from 1949 to 1973.
13 Q. Was Ebasco  employed by Carolina Power      & Light Company  to make a 14    depreciation study in preparation for this case?
15 A. Ebasco was given an assignment      to  make a  depreciation'tudy of 16    the Company's electric plant in service at December 31, 1974.
17 Q. How  long has Ebasco been making depreciation studies for          CP&L?
18 A. Ebasco has been making      depreciation studies periodically for the 19    Company  since 1950, when    it adopted  straight-line depreciation 20    accounting to meet the requirements of the uniform system of 21    accounts of the North Carolina, South Carolina and Federal Power 22    Commissions. These  depreciation studies were    made by Ebasco 23    every  five years since    1950. As a  result of  each study, Ebasco 24    recommended  annual depreciation rates      for all functional classifi-25    cations of property    and  the  Company  generally adopted our 26    recommendations    for depreciation accounting purposes.
 
1 Q. Were these    depreciation studies    made by you  or under your direction?
3 A. Yes.
4 Q. I hand  you  this exhibit entitled, "Carolina    Power  &  Light Company  Depreciation Study      of Electric Plant in Service at  December  31, 1974", and ask    if it was  prepared 'under your supervision and direction?
8 A. Yes,  it was.    (Identify as  Reilly Exhibit  No. 2.)
9 Q. Please explain    this exhibit.
10 A. Reilly Exhibit    No. 2 is the latest of the periodic depreciation studies which    I have  mentioned above. It contains    the results 12    of our current investigation of average service lives, salvage and  cost of removal for the various classes of property which 14    the  Company owns and    the theoretical depreciation reserve 15    requirement at December 31, 1974, based on the assumption that 16    these average service    lives  and  net salvage had been used to 17    compute the annual    depreciation expense .during the expired        life 18    of the property    as of that date. We propose to amortize the 19    difference between the theoretical depreciation reserve,            so 20    computed,    and  the book reserve over the estimated remaining        life 21    of  each class  of property at  December 31, 1974.      This procedure, 22    which has been recommended by the National Association of            Rail-23    road and  Utilities  Commissioners,  results in the inclusion of 24    $ 1,354,000  per annum as part of the annual depreciation expense.
 
The-annual depreciation rates which        we 'recommend    for the year 1975, as shown    in Schedule    l of Reilly Exhibit No.        2, contain the provision    for this amortization.
4 Q. Mr. Reilly,  what are the bases      for the lives, curve types        and 5    net salvage rates you have selected for the various plant 6    accounts?
7 A. Generally the average service lives, Iowa Curve types and net
      ,salvage selected for each account are based on              my  judgment after giving consideration to our analysis of available past 10    retirement experience as determined from            CP&L  property account-ll      ing records; present    and    anticipated future system requirements 12      of  CP&L; and  industry-wide experience      and    trends relating to 13      future  life expectancy    of various classes of property.
14  Q. Mr. Reilly,  can you be more    specific  by explaining to us the 15      approaches  you used  for  each  of the functional .classes of 16      property?
17  A. Yes,  I can. First,  we  looked at the production plant function 18      and segregated    it into  two separate    groups.      One contained the 19      production plants comprising the fueled type of generation and 20      included nuclear,    fossil fueled    steam  plants    and gas  turbine 21      units, while the other contained the Hydraulic Production, Plants.
22      The  decision to approach steam, nuclear,          and gas  turbines 23      generation  facilities    as  functional groups      stems from the    fact 24      that  upon  retirement of    a  generating unit,      all  associated
 
components  are no longer useful.      Modern    plant structures are also of  little, if any,    use  for other purposes.        Massive out-lays of capital for large plants together with            little retire-ment experience    'for comparable plant limit the        use  of actuarial studies.      For the fueled generating plants, there was  little Company    experience with regard to past retirements and there occurred many new and important events since my              last study which, in    my  opinion, would have      a  greater effect on    my selection of lives of these production          facilities    than past-10    retirement experience considered alone.            There were  basically three events which can be classified in two categories:
12    (1) environmental and (2)    fuel, that occurred since        1970 which 13    have had  drastic  economic  effect  on  this functional category.
14    Mr. Reilly, will you please explain the events          which occurred 15    in the environmental category to which          you gave consideration?
16 A. Yes,  I will. Prior    to the late 1960's, there        was  little acknow-17    ledgement on the part    of the government or by the public        as  to 18    the pollution of the environment by our          industrialization. Some 19    electric utilities    were keenly aware    of  it and  included precipi-20    tators in  all their coal-fired    power  plants. Other  electric 21    utilities, primarily    those  in larger urban areas, installed 22    precipitators only in their      newer  larger plants, while      some 23    electric  companies  installed  none  at  all. 'he    action which 24    brought the problem of pollution into focus and to the attention
 
of the public      and  industry, under the pressure of concerned groups, began      in  1970 with the enactment of the "Clean Air Act of 1970", which required that the Administrator of the Environmental Protection Agency (EPA) promulgate national
'5 primary and secondary ambient e
air quality  standards. This act further required each state, within nine months after lf publication, to submit      a plan for the implementation, main-tenance,  and enforcement    of the standards:
          "...as expeditiously      as  practicable but...in    no case 10        later    than three years from the approval of such plant"      for the primary standards.      It also required 12        the implementation of the secondary standards          in 13        "...a    reasonable  time."
14        Two  years    later,  the "Federal Water Pollution Control 15  Act of 1972" was passed.        This act, aimed at eliminating 16  polluting discharges into navigable waters          by 1985, requires 17  that industries      must have the most    practicable cleanup equipment  installed    by 1977, and  absolutely the best techno-19  logical  equipment working by 1983    regardless    of cost.
20  Chemical  limitations will become effective in        1977,  with 21  additional controls in 1983,        and thermal  limitations are to 22  become  effective July 1,    1981,  with possible deferral of 23  compliance to July 1, 1983,        if a system's  reliability would 24  be  seriously affected.
 
1  Q. Mr. Reilly, turning to the fuel category, will you please explain 2      the events that occurred and which you considered in          arriving at' your decision?
4  A. Yes,  I will. Subsequent  to the promulgation of the acts      I just 5      cited, the fuel    oil crisis  of 1973, which continues unabated,      has 6      further aggrevated the conditions        and  affected the economics of electric  energy generation.      The  fuel  oil situation in    1973 and 1974 has  further aggrevated    and complicated the    conditions under which  electric utilities operate.      Fuel costs have risen and 10      probably  will continue    to rise to  new and  higher levels. Even competitive fuels, coal      and  nuclear,  will rise as the demands for 12      these increase with the trend away        from oil. The scarcity of 13      natural  gas will probably limit its      use in the generation of 14      electricity. Most  recently, the stated goal for this nation to 15      become energy independent      will result in    the search  for oil  and gas 16      in'emote    and  inaccessible areas, e.g., the Alaskan slope, from 17      which transportation costs      will be  a  significant factor. The search 18      and development    costs for other exotic energy conversion methods and  attendant  facility costs,    such as coal    gasification, in this
                          /
20      high capital construction and financing era do not presage            a  quick k
21      and inexpensive    solution.
22  Q. What has been the    effect of these events    as they  relate to the
: 23.      determination of average service lives and annual depreciation 24      rates for fueled production plant?
 
1  A. As a  result of these events, the =entire fossil fuel generation function is in a state of flux due to the requirements for air
                                                /
quality control, cooling water pollution control          and the effects of the fuel crisis.        Any monies expended    on  old plants to meet environmental protection requirements must be recovered over the remaining    life of  the  facility.    (Fuel costs have risen  and  will continue  to rise, forcing      difficult decisions,      as to the continued use of    an  old, less efficient plant.)          The economics of increasing    fuel costs tied to additional substantial 10      outlays of capital for    air quality    and/or water pollution control may  well limit the    life of  old plants.      We,  therefore,    deem  it 12      advisable to lower the service        life of  existing  steam generating 13      facilities  notonly in order to recoup the capital spent            on 14      environmental protection equipment but also due to            a  distinct 15      possibility of early retirement for economic reasons.
3 Therefore, 16      we have recommended the lives and depreciation rates              shown  in 17      Schedule    II of my Exhibit  No. 2  for  steam, nuclear, and other 18      production plant accounts.
19              Further,  if the  expected amount of      capital required for      SO 20      removal  in the future is actually spent to        make older plants meet 21      environmental requirements,      then the annual depreciation rate as 22      recommended    in this report could    be inadequate.
23  g. Mr. Reilly, will you    summarize the    effects of your consideration 24      of these events?
 
1 A. Yes. For Steam Production Plants,        all  of the aforementioned were taken under consideration        in our    recommendation  to increase the normal depreciation rate for those steam gene-rating facilities    we have  classified    as "Other Steam Production Plant" from the current 2.468 percent to 2.947 percent.      New steam  plants of large size      will be    subject to even more stringent      air  and water control equipment than older plants.      While the expected    life of    production plant equipment    itself  may not be changed significantly, the 10      associated    environmental equipment      may  require replacement 1 or  2  times over the    plant's lifetime. Little historical 12    knowledge    is available for plants operating at high temperatures.
13    It would    be  appropriate to expect      a  higher level of retirement 14    and replacement    of plant components subject to the higher 15      temperatures    and steam pressures    to result.      It is  our opinion 16      that  new steam    production plants represented by Roxboro Nos. 1, 17      2  and 3,  Asheville  No. 2, and Sutton No. 3,        plus any  new  plants 18      coming    into service should    have a normal      depreciation rate of 19      3.452 percent, which      is  0.595 percent higher than the 2.857 percent 20      recommended    in 1969. The  rates for both old and newer steam production include      an allowance    of  5  percent net cost of removal 22      (negative net salvage for Account          311  Structures    and Improvements 23      and Account 312  Boiler      Plant Equipment.        The Iowa Type Curve 24      applicable to the steam plants        was  selected by judgment.
 
With regard to Nuclear Production Plant, at the time of our previous study the Company did not have any Nuclear Production Plants in service.        No  statistical  data are    avail-able to  make a  historical analysis to      determine the average life applicable    to this relatively      new  type of plant, either on a Company  basis or on an industry-wide basis.          Therefore, by judgment we have selected      a  depreciation rate of 4.225 percent. This  is based on a 25-year average        service  life for all  components,  together with    a  negative    10 percent salvage 10 factor for Accounts    321 -  Structures    and Improvements,    and 322  Reactor    Plant Equipment.
12      With regard to Other Production Plant, the Company's 13 historical  data are  insufficient to apply statistical techni-ques to determine the average      life of    the gas turbines and 15 related equipment included in Other Production Plant.              The 16 Company  is currently using    a 30-year average      life. Due  to the 17 critical fuel    supply for  oil-or gas-fired turbine        peaking 18 plants,  it is  our opinion that the shortening to        a  25-year
'9  average  life is  reasonable  at this time.      Since we have 20 estimated zero percent net salvage,          the recommended annual 21 depreciation rate is 4.000 percent.
22      Turning to the balance of the production function, Hydraulic 23 Production, the depreciation rates        I recommended    in my Exhibit 24 No. 2 are based on the composite        of the average    lives assigned
 
to each of the major components comprising the account.            The annual depreciation rate for each primary account for each plant is  based on the composite    of the average lives assigned to each of the major components comprising the account          as  of December 31, 1948,    in the  Ebasco study as  of that date.
Certain changes were      made  to the original average lives as assigned  in  1948. The  lives  shown  of the detailed sheets reflect  the changes and support the annual rates used.
The  rates for, the Walters Plant were originally used in 10 our previous report      entitled, "Carolina    Power &  Light Company-Walters Project No. 432      -  Actual Legitimate Original Cost and 12 Accrued Depreciation (Recalculated with 150 year Ceiling            Life) 13  Summary  of Reserve Balances Years      1930  to 1956  Inclusive",
14 which was submitted and accepted by the Federal Power Commission.
15 The  Blewett Falls and    Tillery rates  were used  in our report 16 "Carolina  Power  & Light  Company -  Blewett Falls and    Tillery 17 Hydroelectric Developments Projects        No. 2206  Summary    of 18 Recommended  Depreciation Rates and Reserve Balances'Years          1912 19 to  May 1, 1950, Inclusive      (Dated) November 1961  Revised 20 January, 1962.      These  rates were accepted by the Federal      Power 21 Commission. The  determination of rates for the Marshall hydro-22 electric plant    Project No. 2380      follows the  same method    that 23 was  applied to the other licensed projects.
12'-
 
Q. Mr. Reilly,  now  that you have explained the basis for your determination of lives for production function,          will you 3    please continue with your explanation of how you selected 4    the lives and depreciation rates for the other functional' groups?
6 A. Yes,  l will. As  I indicated  in Exhibit  No. 2,  in general, the investigation of the service lives and mortality characteristics of the property in        each account,  other than production, plant, involved the following steps:
10          1)  An  analysis of available past retirement experience I
from Company's acco'unting records, and 2) the modification 12    of the results of the analysis of        such past  retirement 13    experience to      reflect  judgment as to (a) present and    antici-14    pated future system requirements and (b) industry-wide 15    experience and trends relating to future        life expectancy  of 16    various classes of      utility property. The  Actuarial  Method 17    of  life analysis    using dollar units  was employed  in compiling 18    mortality statistics.        Data through December 31, 1973, was 19    analyzed.
20          The  periods of years selected to provide experience data 21    for the    life studies    involving the  methods  l will discuss 22    shortly,    was  limited  by the following considerations:
23          1)  Primary accounting data must be on a consistent basis
: 2)  Experience used must be    fairly indicative of  what 25                might reasonably be expected in the future 26          3)  Availability of useful data
 
1 Q. Mr. Reilly, earlier  you mentioned "curve types" and "net 2    salvage". Can you  explain these terms    and how you  arrived 3    at these factors?
4 A. Yes. The  actuarial  method used  to determine average service 5    lives for the various types of property also yields informa-tion  as  to the dispersion of retirements about that average age. In our study,  we matched  these dispersions with those, of the well  known and  frequently 'used  Iowa Curves.
Net Salvage  is the difference    between the cost    of removal 10    and salvage  value received fram property retired.        The  net salvage percentages    used  in this report are    expressed  as a 12    percent of original cost.
13 Q. Mr., Reilly, at this time will you explain the actuarial studies 14    you made?
15 A. Yes. The  Actuarial  Method  of life analysis    using dollar units 16    was employed  in compiling mortality statistics for all        accounts 17    other than the production plant.      Data through December 31, 18    1973 was analyzed. This method of analyzing past experience 19    represents  the application to    industrial property of statistical 20    procedures  developed  in the life insurance field for investigating 21    human  mortality. It is  distinguished from other methods of              life 22    estimation by the requirement that      it is  necessary  to  know        the 23    age  of the property at the time of      its  retirement  and .the  ages'f 24        survivors, or plant remaining in service; that is, the installation date    must be known  for  each  particular retirement
 
and  for  each  particular survivor.      The  application of this method  to the Company's experience involved the          statistical procedure known as the "annual rate method" of analysis.
This procedure relates the survivors of a given age in an account to the survivors of the previous age-year,            thus yielding  a sequence    of annual survival probabilities* from which a survivorship characteristic can        be  constructed. Similarly the  ratio of retirements of      each age.-year  to the survivors of the previous age-year      may be used  to get  a  series of mortality 10    probabilities which      may be  converted into a survivorship characteristic. The mathematical    combination of these two factors results in    a  series of relationships which,        if plotted 13    on graph paper,    form what    is  known as a  survivor,'r mortality 14    curve. The  length of this curve depends primarily upon the 15    years of experience available; so that,          if the  experience band 16    of years is short in relation to the average          life of  the property, 17    an incomplete    or stub survivor curve results.          There are  a number 18  . of acceptable methods of smoothing        and extending    this stub 19    survivor curve in order to      compute the area under      it from which.
20    the average    life is  determined. The well-known Iowa Type Curve 21    Method was used    in this study.      In 1935, the Iowa Engineering 22    Experiment Station of Iowa State College published            Bulletin  125 23~  entitled, "Statistical      Analyses of  Industrial Property Retire-24    ments" by Robley Winfrey.        This  bulletin describes the
 
development of 18 type      mortality curves    and  their applicability to 'industrial property having      .a  wide range of mortality characteristics. Since  their publication in      1935, these .type curves have been frequently used by public          utility operating companies    for depreciation accounting, tax, rate        and  other purposes. They have  also found general acceptance with the Securities  and Exchange Commission',      the Federal Power Commission, the Bureau of Internal Revenue and          many state public    utility '
commissions.
10 Q. Please continue with your explanation of your          actuarial studies ll    of  life analysis.
12 A. In the mortality study of the        Company's  property, instead of mathematically smoothing and pro)ecting the stub survivor curve 14    to determine the average      life of    the group,  it was  assumed  that 15    the stub curve would have the        same  mortality characteristics      as 16    the type curve selected.        The  selection of the appropriate type 17    curve and average    life was    accomplished by    plotting the stub 18    curve on transparent    graph paper and superimposing        it on  Iowa 19    curves of the various types and average, lives drawn to the            same 20    scale, and then determining by judgment which Iowa curve type 21    best suited the stub.      In  some    accounts when  this  method was 22    used, average    lives different from those indicated        by the stub 23    curve were selected on the basis of judgment.            Such judgment 24    took into  a  consideration factors which indicated that the 25    Company's past experience was not a reasonable          criterion of 26    future  life expectancy for    the    facilities now  in service in  those 27    par t'icular accounts.
 
1 Q. What was  the basis of your determination of net salvage rates?
2 A. The net salvage percentages        used  in this report are      expressed 3    as a percent    of original cost      and were based  primarily                on judgments    However,  in determining this    judgment, considerable weightwas given to the      results of    an  analysis of the Company's experience with respect to salvage and removal costs for the period of years 1969-1973, inclusive.          The  net salvage ratios shown on Column V      in the  summary  in  Schedule IX      of this exhibit  may be  explained as follows:
10          1. Where  the  ratio is  shown as  unity (1.00),      it was assumed  that the net salvage in that particular
                                                                                        '2 account would be zero.
13          2. Where  the  ratio  was  less than unity,    it was              assumed 14              that the salvage exceeded the demolition costs.
For example, where the net salvage was 20 percent, 16                the net salvage    ratio  was expressed  as .80.
17              Where  the  ratio  was  greater than unity, I'.
it was,'ssumed 18                          that the demolition costs exceeded the 19              salvage. For example, where the net salvage was 20              minus  5 percent, the net salvage      ratio  was expressed 21              as 1.05.
22          These net salvage      ratios  were used  in computing the annual 23    depreciation rate for each primary account in order that the 24 ,'ate    could be applied to the gross balance in the account
 
when  calculating the annual depreciation accrual.          For example, if the  average    life for  an account were 50    years, the annual depreciation rate with zero net salvage would          be 2.0  percent.
However;  if the >et  salvage  ratio  were .90, the annual depre-ciation rate adjusted for net salvage would          be the product of' the two, of 1.800 percent.
I 7 Q. Where  in your Exhibit    No. 2're    the results of your mortality 8    study summarized?
9 A. Schedule  II summarizes    the results of    my  mortality study. In 10    Column IV under the heading Average        Life  and Iowa type curve selected,  the  letters  .R, S, and  L, together with the numerical 12    suffix,  which accompanies    them, represent    the Iowa, type curve selected for each account.        The number  prefixed to the letter 14    is  the average    life in  years, which together with the net 15    salvage  ratio  shown  in  Column V determines      the annual depreci-16    ation rate    shown  in Column VI    of the  Summary. Column  VII 17    represents    the application of the rate      in Column VI  to the 18    Original Cost at    December 31, 1974,    for  each primary  plant account,  is  used to determine the annual      depreciation rate 20    applicable to each of the functional groups.
21 Q. Mr. Reilly, will you please describe        Schedule  III of your  Exhibit 22    No. 2?
23 A. Yes. Schedule    III is  a comparison  of the estimated Reserve 24    Requirement at December 31, 1974, based on the average service
 
1  'ives,      curve types and net salvage selected          for  each primary 2    plant account, with the book Reserve for Depreciation.                  The 3    comparison indicates a difference of          $ 34,536,000.
4 Q. Mr. Reilly,  can you explain the reasons        for this difference?
5 A. Yes. The  largest part of, the difference between the calcu-lated reserve      and the book reserve    at  December 31, 1974,      is
      'due to the change in average        life and    net salvage percent selected for Steam Production Plant.            This change has been t
caused  primarily by the environmental requirements            imposed on 10      this type of plant      as  well  as the  fuel situation, both of which    I discussed in detail      and occurred since our 1969 depre-12      ciation study.      Schedule  III in  this Section    shows  that of 'the 13      $ 34,536,000    difference between the calculated reserve            and the book reserve,    $ 23,005,000  is in the  Steam    Production Plant.
15            The  difference in Transmission Plant        and  Distribution 16      Plant is caused mostly by the inclusion of 'Rights of            Way 17      accounts in depreciable plant        for depreciation accounting
-18      purposes only    after  1968, when the  Internal    Revenue Service 19      allowed the recovery of such costs through a depreciation 20      deduction for Federal Income Tax purposes.              Prior to that time, 21      the  Company  treated these accounts as nondepreciable          'and no 22      depreciation accrual      was made  to the book reserve for these 23      accounts.      Changes  in the selection of    average    life,  curve
 
type and net salvage percentages        based on experience since the 1969 study and judgment have created        the  relatively  minor differences between the calculated reserve          and the book reserve in the other functional plants.        Since our 1969 study, the difference between the calculated reserve          and the book    reserve r
has increased    from about  1  percent of depreciable plant to about 2.5 percent.
As  discussed  on page 187    of Reilly Exhibit    No. 2,  I feel that the proper treatment of this difference at this time is 10    to adjust the normal annual      recommended    depreciation rates to include  an allowance  that  will adjust for this difference over 12    the average remaining life of each functional plant in which a 13    difference exists. The computation on Schedule I derives the 14    composite recommended depreciation rates          for 1975'or    each 15    functional plant, including this adjustment.            The  calculations on Schedule    II in this exhibit determine the actual          amount  of 17    normal depreciation based on plant        in service at    December 31, 18    1974. By "normal"  we  refer to that    amount  of depreciation
                            \
19    using rates that are based on the average service            life and  net 20    salvage factor only.      To  this  amount,  I  added the amount 21    necessary  to amortize the difference between the 'calculated 22    reserve -and the book reserve per Schedule        .III to  determine the 23    total depreciation    from which the recommended rates have been
  '4 derived in Schedule    I for  the year 1975.
 
1 Q. Mr. Reilly, can you summarize    for  us the  effect of  CP&L adopting 2      your recommended depreciation rates?
3 A. The adoption of  my recommended    depreciation rates, together with 4    . the amortization of the difference between the theoretical depreciation reserve    and the book reserve as    of December 31, 1974, will allow  the  Company to recover    its investment  in Electric Plant in Service in  a  rational  and  uniform manner over the remain-ing life in a  plant in service estimated      by me as  of December 31, 1974.
 
A. My  primary responsibility      was  the assignment and allocation
                                                        )
of rate base components, revenues, expenses,          and  capital structure to the South Carolina retail operations, which are 4    subject to the jurisdiction of this Commission.            The  results of these assignments      and  allocations are  shown on the    various test period exhibits filed in this proceeding.            The  original Applications were based      on a 1974  test period. Subsequent    to the  filing of    the  original exhibits, the test period      has been updated to the year 1975.        The  revised exhibi.ts for the 1975 10    test period are presented in the testimony of          Mr. Bradshaw and Mr. Davis, to whom      I furnished the results of the allocation of the system totals to determine the amounts for the South 13    Carolina    retail operations.
14            I was  also responsible for preparation of the 1974 Retail 15    Operations Cost Allocation Study based on the present rates annualized. This study provides an indication of the relative 17    rates of return earned by the various        retail  customer rate 18    classes. My  testimony  'will include  a discussion of the proce-19    dures used to accomplish the study and the results obtained 20    for the retail rate classes.
21  Q. Were  the allocations to obtain the South Carolina          retail 22    jurisdictional operating results        accomplished under your super-23    vision  and  direction?
24  A. Yes, they were, and they consisted        of methods previously 25    presented    to this. Commission. In summary,  I would  state that
 
the power supply allocation was accomplished on the basis of coincident peak    demand. This allocation method states the power supply  responsibility for production      and  transmission cost  on the .basis of the demand at the time of our annual summer peak demand. We  believe that this method properly reflects the cost of providing service        and  relates our revenue levels to the peak load of our system.          We  have used this  peak load cost formula      in our last  two  rate filings prior to this  case and recommend    its  approval again    in this 10    proceeding. The  allocation of the remaining cost items        was accomplished  in the  same manner as    in our previous rate filings.
12 Q. Would you please    explain the jurisdictional allocation study in 13    more  detail?
14 A. The  results of system operations including adjustments          were 15    apportioned to  retail service in    South Carolina by a series of 16    steps which began with    a  study to  identify those items related 17    solely to service to specific classes of customers.            Those 18    items were then assigned      directly to the related classes.        Those 19    matters which arose from joint-use and thus could not be assigned 20    directly to specific classes      were allocated by the    application of 21    standard analytical methods.        All items  were grouped according to 22    the functions to which they relate        production, transmission, 23    distribution, administrative      and general, sales and customer
 
accounting. Allocable items were also classified      as  to whether they'were demand-related,      energy-related,  or customer-related.
Allocations of demand-related items were        made using coincident peak demand    factors. Energy-related items were allocated by using kilowatt-hour ratio factors.
6 Q. Will you please explain briefly      how each  major revenue, expense, 7    and  rate base item  was  allocated, beginning with operating 8    revenues?
9 A. Operating revenues from sales at      retail in  South Carolina are 10    readily identified    and  therefore have been assigned directly to the South Carolina    retail class. Other operating revenues consisting of    a number  of miscellaneous items were either 13    assigned    directly or apportioned    by appropriate analysis and factors.
Q. Please describe the    allocation of the operation    and maintenance 16    expenses.
17 A. Before the operation and maintenance expense items could be 18    functionalized into categories for allocation,        it was  necessary 19    to prorate the supervision and engineering expenses for each 20    expense    account. An  analysis provided the amount of the payroll 21    charges included    in the total  expense  items. The  respective 22    supervision and engineering expenses were then apportioned to 23    the various expense accounts based on      this labor  component. By 24    this  means  the primary accounts were restated to include a pro-25    rated portion of the supervision and engineering expense.
 
The expenses    as thus  restated were then classified as either energy-related,      demand  related, or customer-related.
The  production expense items classified as energy-related are fuel, the energy portion of purchased power,            boiler plant maintenance,    electric plant    maintenance,    reactor plant maintenance,    and  nuclear electric plant maintenance..          The remaining power production expenses were classified as demand-related.
The  transmission expense      was assigned    b'etween power supply 10 production and power supply transmission based on the ratio of the plant in service.      The  distribution    expense was divided 12 functionally    between substations,      overhead  lines,  underground 13 lines, meters,    and  other distribution expense.        These  function-14 alized expenses were assigned to        each  state  and then  allocated 15 to,the jurisdictional classes within the states            on the  basis of 16 the respective    distribution plant accounts.
The customer    accounting expense was assigned based on          a 18 specific analysis which separated the cost involved              between 19 wholesale and    retail service in      each  state. A portion of the 20 expense  of the customer services personnel        who  are  directly 21 involved in wholesale sales      was assigned    to the wholesale 22 operation in each state.        The  remaining sales expense was 23 assigned  to the  retail class.
 
Regulatory expense has been analyzed and assigned to the respective jurisdictions.        The  remaining administrative and general expenses were allocated to the customer classes principally    by the use of labor    factors. Certain items such as  property insurance    and maintenance. of general plant were allocated    on  plant ratios.
The  operation  and maintenance  expense  adjustments were allocated    on  the same  basis as the items to which the adjust-ments  related.
'0  Q. Would you please    explain the allocation of the depreciation expense?
12 A. Depreciation expense      was assigned  in  accordance with the assign-13    ment and    allocation of the functional plant to which the depre-14    ciation related.      The adjustments  to the depreciation expense 15    were  similarly functionalized      and allocated  on the  basis of the 16    respective functional plant account.
17 Q. Please describe the allocation of the remaining operating 18    expense items.
19 A. Taxes other than income were assigned        for allocation  as related 20    to labor, property,    KWH  sales, or revenue and were then allocated 21    by the respective      allocation factors.      Unemployment taxes were 22    considered labor-related, property taxes were considered related 23    to plant investment, the South Carolina electric power generation 24    tax was  classified  as KWH-related, and revenue taxes such as the 25    North Carolina gross receipts tax were treated as related to 26    revenue.
 
State income taxes were assigned specifically to the respective states and then allocated to classes        on  the basis of the ratios of income before taxes.        Federal income taxes were calculated    for states  and  for classes using allocated taxable income.      The provision for deferred income taxes and the investment    tax credit were functionalized into production, transmission, distribution      and general categories,    and then 8    allocated    on the basis of the respective plant allocations.
9 Q. Will you  please explain the allocation steps used to determine 10    the portion of the electric plant used in providing service to ll    South Carolina    retail  operations?
12 A. The  allocation of electric plant in service consisted of        two 13    basic steps. The  first step was to specifically assign    all  items 14    of cost for which sufficient information allowed        a  specific as    separation between classes.      This step involved separating the 16    cost associated exclusively with the wholesale operation          and  also 17    joint  costs which were allocated on a specific basis.        The second 18    step  was  to allocate the costs where the    joint  use was so thorough 19    that  a  specific analysis  was  not practical. These costs were 20    assigned  for allocation to the classes of service      and the  alloca-21    tions were accomplished by the      use of allocation factors developed 22    for the respective classes.
23          Allocations of the power supply production      and .power supply 24    transmission    facilities  were accomplished  using the coincident
 
peak demand  allocation factors.        All allocations of facilities below the  level of  power supply transmission were accomplished by use of  NCP demand    allocation factors.        The NCP  factors for each  of these specific allocations were developed by            an  analysis of the  demands  imposed on the      facilities    being allocated.
The  production plant in service        was  allocated between classes of service by      KW  demand  allocation factors developed from system load data.        These  KW  demand  allocation factors    were based on data adjusted      to the production level.        No production 10 plant account dollars were specifically assigned to classes of service. The  transmission plant in service          was  allocated 12 between the classes    by  KW  demand  allocation factors developed 13 from system load data.        No  transmission plant account dollars 14 were  specifically assigned.        It was  necessary,    however, to 15 separate  the transmission plant into two levels for allocation 16 by  KW demand  factors. Since the function of the step-up trans-formers at the various generating plants            is considered to    be 18 production, these    facilities    were  allocated using the production 19 KW  demand  allocation factors.        All other transmission facilities 20 were allocated using transmission          KW  demand  allocation factors.
21      The investment    in distribution facilities        was assigned 22 between the states    on a geographical basis as shown          directly  on 23  the books of the    Company and between        the wholesale and    retail 24 classes on the basis of specific analysis.              General plant was
 
first placed in    the functional categories      in its relationship of use with the production, transmission, or distribution facilities. The amounts thus      functionalized were then assigned on the same b'asis as the respective functional plant accounts. The  item for intangible plant        was assigned  on the basis of the other electric plant.
The depreciation reserve distributed          on the books    to the functional plant from which        it results  was assigned  in accordance with the plant assignment.
10 Q. Would you please now describe        the allocation of the other rate base items?
12 A. Net nuclear  fuel, which consists of nuclear fuel assemblies in 13    the reactor, nuclear fuel in process, and spent nuclear fuel, 14    was allocated by the use of KWH energy factors.            The fuel portion 15    of materials    and  supplies  was  allocated by energy factors.        Other.
materials  and  supplies were analyzed as to their type and were 17    allocated according to the assignment of related plant.              The bank 18    balance portion of the cash working capital allowance was assigned 19    in  accordance with plant investment.          Prepayments    were assigned by 20    specific analysis or      by  allocations  based on gross    plant. The 21    cash allowance was assigned        in the  same  proportion  as the  operation 22    and maintenance      expenses. Deducted from cash working      capital  were 23    average tax accruals and customer deposits.            The tax accrual offset 24    was  allocated in accordance with plant investment.            Customer 25    deposits were directly assigned to the proper jurisdiction.
 
1 g. Where are  the results of applying these allocation procedures 2    to the  1975  test period    shown  in this proceeding?
3 A. The  results of  my  5urisdictional allocation study are      shown in Davis Exhibit    No. 1. I provided to Mr. Davis the South 5    Carolina  retail allocated portion of      the cost of service that 6    he  is presenting in his testimony.
7 g. Will you please    now  turn to the next part of your testimony relating to the procedures      and  results of the Retail Opera-tions Cost Allocation Study for the        1974  test period. Please 10    summarize what    is  meant by a    retail  operations cost allocation 11    study.
12 A. A  retail  operations cost study allocates system cost and devel-13    ops a  rate of return for each of the retail classes.          The  study 14    allocates the revenues, expenses,        and  rate base between the 15    various  retail  classes. The  rate of return is derived by 16    measuring net operating income as a percent of average net 17    original cost rate    base.
18          Horne  Exhibit  No. 1 describes    the procedures  that are used 19    in our retail cost allocation studies.          The methods and )udgment 20    used  in our retail cost allocation studies are extensions of the methods used    in the preparation of jurisdictional allocation 22    studies. While advice    for portions of the study is obtained from 23    consultants,    the studies are accomplished by      Company  personnel.
 
Recognized and accepted      allocation procedures are    used through-out the studies.      For the major components,    these procedures conform to those used      in the recent rate hearings before the regulatory commissions in the two states which the          Company serves.
6 Q. How  were the cost data and customer information obtained          to 7    apply these allocation procedures in the        retail  studies?
A. The  basic cost data for the study were taken from the books and records of the Company.      Adjustments have been    made  to include 10    the effect of known changes during the year.          However, these adjustments do not include      all the items that would be necessary 12    if the  results of this type of study      were to be used to determine the rate levels of the Company.
14          Fundamental to appraising the      results of this type of allo-1S    cation study is    a recognition that the use of      an average 16    original cost rate    base  without  all  of the adjustments normally 17    included in    a ratemaking proceeding    is appropriate in a study of 3.8    the relationship of rates to each      other but not in considering 19    the adequacy of the overall rate of return.
20  Q. Was  the document marked Horne Exhibit No.        2 prepared by you or 21    under your supervision and direction?
22  A. Yes,  it was.    (Identify) 23  Q. What  is  shown  in this Exhibit?
24  A. This Exhibit presents the results of our Retail Operations Cost 25    Allocation Study for the year      1974 on the  basis of the present 26    rates annualized.
 
1 Q. Does  this  Study  for 1974  provide the information which is 2    necessary    in the establishment of the rates for the various retail  classes of service?
4 A. No. This Study only provides an indication as to the      relative rates of return that are being earned by the various rate classes. It attempts  to analyze  and  consider cost factors in providing service to the various      customer classes. This study, however, does not consider      all  of the factors which are essential in setting rate levels and the design of the 10    resulting rate schedules.
The end  results of the accounting    and the engineering 12    procedures    involved in cost allocation studies do not establish 13    value of service or even levels of reasonable rates.        The 14    results simply reflect the total cost assigned to the rate 15    classes by following basic principles with logical and 16    supportable procedures starting from the premise of allocation 17    joint  costs. The  resulting rates of return    can serve only as 18    a  guide, under the assumptions of the study, to the relative 19    earnings of the various rate classes.        Proper rates can be 20    established only after consideration of        all the factors  rele-21    vant to their justness and reasonableness.        A retail class cost 22    allocation study is    one  of the aids in that task.
 
South Carolina Public Service Commission CAROLINA POWER    &  LIGHT COMPANY TESTIMONY OF JAMES M. DAVIS, JR.
1 Q. Please state your name and address.
2 A. James M. Davis,  Jr.,  Raleigh, North Carolina.
3 Q. What  is your position with Carolina        Power  &  Light  Company?
4 A. I am  Assistant Director of Rates      and  Regulation.
5 Q. Will you briefly describe your educational          and  professional 6    background.
7 A. I  am a  graduate of North Carolina State University, from which
            '
                                                    /
I  recei'ved  a  Bachelor of Science Degree in Mechanical Engineer-ing. After three years'ervice        as an  officer in the .U. S.
10    Air Force,    I was  employed by  Pratt and  Whitney Aircraft as a test engineer in the Experimental Engineering Department.              In 1965,    I went  to work with Carolina Power      & Light  Company as an 13    engineer in the Special Services Section.            I joined  the Rates 14    and Regulation Department        in February,  1968, and  in July,  1970, 15    I was    named  to my  present position.
16          My  education in the ratemaking area has consisted of          parti-17    cipation in the development of the load survey, cost analysis, 18    rate evaluation,      and  rate design programs of the      Company. This 19    work has included the studies that were necessary            in the prepara-20    tion of the filings        and case  materials for  retail  and wholesale rate increase requests, including our          Company's  prior requests to 22    this  Commission.      I have  attended a training program conducted by
 
Ebasco Services,    public  utility consultants,    and I have  worked with  a number  of rate consultants in the preparation of rate case  material;    I have  attended meetings of the Rate Research Committee of the Edison      Electric Institute. I am a  registered 5    Professional Engineer in the State of North Carolina.
6 Q. Have you    testified before    a regulatory authority prior to this 7    case?
8 A. Yes,  I have testified    before this Commission in prior rate 9    proceedings and before the North Carolina        Utilities Commission 10    and  the Federal Power Commission.
11 Q. Please summarize your duties      with Carolina  Power &  Light 12    Company.
13 A. The Department    of which  I am  assistant director is responsible 14    for the development, issuance,      and  interpretation of the rates and  service practices of the    Company. I am  responsible to the 16    Uice President and Director of Rates and Regulation          for the 17    direction    and supervision of the studies underlying the theoretical 18    and  practical aspects of our rate structure; the preparation of 19    rates  and revenue comparisons;    the direction and supervision of 20    cost allocation studies; and the development of financial          and  cost 21    studies for rate case presentation.        I supervised the rate of return 22    studies underlying the exhibits which have been filed in this 23    proceeding, and supervised the preparation of the proposed rates 24    and  rate schedules.
25 Q. Mill you  please explain the scope of testimony you .intend to        offer 26    here?
 
1 A. I will present  the proposed rates, including    .a  fuel adjustment 2      clause for the recovery of current fuel costs, for which the 3      Company  is requesting approval of this proceeding.        I will also 4      present the actual operating results of the      Company  .during the test period consisting of the calendar year      1975, with appropriate adjustments.      This material will be    presented  on both  a system-wide  basis and, as indicated in the testimony of Mr. Horne, as allocated and apportioned to the operations which are 'subject to the    jurisdiction of this  Commission. My 10      testimony  will show  the monetary effect that the proposed rates ll      would have had on the Company's operations,      as  adjusted, had the 12      changes been  in effect during the test period      1975.
13 Q. Where have you shown the 1975      test period operating results with 14      the present rates in effect?
15 A. ~
Davis Exhibit No. 1  sets forth the operating experience for the 16      historical test period in this proceeding.        This Exhibit    is in 17      the  same  format as Exhibit    G filed with our Application and has 18      been updated to  reflect    the year 1975 results. Column  7  sets 19      forth the allocated    South Carolina  retail  operations. The  proce-20      dures used to obtain the allocations were described          in the 21      testimony of Mr. Horne.
22            This Exhibit shows the actual 1975 test period operations
        '
23      adjusted to properly reflect for the purpose of        jurisdictional 24      ratemaking those changing conditions which were not          fully reflected in the actual results of the test period.          Included
 
therein, are those proforma adjustments explained in the testimony of Mr. Paul Bradshaw.          In addition,  I have included certain adjustments which were calculated under my  direction  and  supervision.      These adjustments  include the annualization for the effect of previously allowed rate 6    increases and the normalization and annualization of the
'7    addition of the Brunswick      No. 2  generating unit.
8 g. Will you please explain the adjustments          which you have 9    included; starting      first w'ith  the adjustment for prior rate 10      increases?
11  A. During the test period 1975, the        Company  received a  retail 12      rate increase which      was  not  fully reflected in    the test 13      year revenues.      It was  necessary  to compute the annual effect 14    'of this  approved increase and add to the        test year  revenues 15      the additional revenues that would have been produced had 16      the approved increases been in effect throughout. the test 17      period. These adjustments      restate the test year revenues to 18      reflect fully the effect of the prior rate increases            which 19      occurred during the test period.
20            The second    adjustment which    I  have included adjusts revenues, 21      expenses,  and  rate base to reflect the      full annualization    of the 22      addition of the Brunswick      No. 2  nuclear generating unit.      This 23      adjustment  is essential to state the operating results 'of the 24      Company on  the basis of a    full year's    operation of this  new
 
generating resource.        The adjustment    includes  many aspects    to fully reflect    the effect on our operating results from the addition of Brunswick        No. 2. Each  respective ad)ustment to revenues,  expenses,    and  rate base  was computed on    the basis of the Brunswick      No. 2  unit operating at    a 72%  capacity factor during the test period.        This  availability    was  selected because  it reflects a full year's        operation, including    a  refuel-ing cycle. We  selected  a 72%  capacity factor    on the assumption that the unit would      be  available  on a basis  equivalent to ful'1 10 power operation approximately        85%  of the hours during the year, except'for  a  six-week outage for necessary maintenance and 12 refueling. This reflects an optimistic estimate of the            avail-
"13 ability  of this    new  unit  and  reflects a'full year's operation at 14 a  substantial availability        and load  factor.
15      In order to    compute the    effects of the availability of 16 Brunswick No. 2  for the entire test period,      it was  necessary    to 17 develop  a power    estimate which would restate the generation from 18 system resources      to include the addition of this large nuclear 19 unit. Purchases    and interchange    transactions were also 20 analyzed to determine        if purchases    could have been reduced to an 21 economic advantage      if the  nuclear unit.Sad been available.          When 22 this analysis    was completed,      the result stated the adjusted 23 generation from each of our existing units.            This reduced'genera-24 tion  was then analyzed      to determine the fuel requirements that
 
would have existed with the reduced generation.              Our  fossil fuel  purchases    during the year    1975 were reviewed    to determine the effect of the      fossil generation    which would have been replaced by the nuclear unit.          In order to evaluate the fuel purchases,  we  eliminated the highest price spot purchases that were made  in  each month  at each of the plant locations based on the reduced    generation for that respective plant.          We  did not reduce contract purchases at any of our plant locations.
The reduced    fuel purchases    were then processed      through our 10 fuel inventories to determine adjusted unit fuel prices.                    The adjusted fuel prices were then used as          a  basis to calculate 12 fossil fuel    adjustment factors that would have resulted from 13 the adjusted fuel purchases        and consumption.      This calculation 14 was necessary    to reduce the revenues that would have been by the  fuel adjustment factor.                            'roduced 16      The  completion of these detailed calculations to            fully 17 annualize the operation of the Brunswick No.            2  nuclear unit 18 resulted in the following adjustments.            South Carolina    retail 19 revenues were reduced by      $ 5.0  million. The  test year fuel 20 expense was reduced by a net        of $ 4.3 million. Purchased      power 21 expense was reduced by      $ 1.0  million. Other  0&M  expenses  were 22 increased by    $ 711,000. Depreciation expenses,      property taxes, 23  fuel deferral,    and  working capital were also adjusted to con-24  form to the related adjustment items.          The combined    effect of
 
these adjustments was to state the test year on the basis of a full annualization    and  normalization for the addition of Brunswick No. 2  generating unit.        The adjustments    to fuel 4    expense and purchased    power have also been included        in the base cost  for the  proposed  fuel adjustment formula in Davis Exhibit  No. 3.
7 Q. Mill you  please describe the rates proposed by the Company              in 8    this  proceeding?
9 A. The Company has    filed  two  rate increase applications in this    'A 10    proceeding. On  July 31, 1975,    an  application  was  filed for authority to adjust the rates for residential service.              The 12    effect of this    initial application      was  to equalize the rate for 13    residential service    between the    state of South Carolina      and 14    North Carolina. The  Application    was assigned    Docket No. 18,361,
            'I 15    and the proposed    rates went into effect under bond, subject to 16    refund,  on September    1, 1975,  in  .accordance  with the 17    Commission's Order No. 18,532.
18          On August  ll, 1975,  the Company    filed  an additional Appli-19    cation requesting    a  general increase in      its  rates  and charges 20    for retail service in      South Carolina.      This Application was 21    assigned Docket No. 18,387.        Subsequent    to the  filing of    the 22    general application, the Commission consolidated the two dockets 23    into  one proceeding.      Exhibit  B  filed with    the Application on
 
August 11, 1975, contains the rates and rate schedules            proposed by the Company.      For convenience,    the proposed schedules are presented with this testimony as Davis Exhibit            No.'.
It should  be noted  that these schedules contained        a  "roll-in" of 5.54 mills per    KWH  to reflect    an increase    in the cost of fuel reflected in the    base  rate charges.      At the time of the filing,  it appeared    that this level of cost      was a reasonable expectation  for,the current      cost of fuel. However, the Company's experience has been more favorable, and the cost of fuel has 10    stabilized at  a  level below the requested roll-in figure.          .As a result of this    improvement  in the cost of fuel,      an adjustment was made  at the time the requested rates        became  effective under      bond 13    for service rendered    on and  after  March 1, 1976.      Rider No. 35A, 14    which has been included as      a  part of Exhibit    B, was placed    into 15    effect to  reduce the requested      rates by $ 0.005536 per    KWH  t'o 16    remove the  roll-in requested      by the Company and allow the 17    presently approved fuel clause to continue in effect.
18 Q. Does  the Company propose that the      filed rates continue in effect        on 19    a permanent  basis including Rider No.        35A to adjust for the 20    difference in fuel cost?
21 A. No, we do  not. We  have simply made an adjustment to allow the I
filed rates to    go  into effect  on an  interim basis, pending      a 23    decision of the Commission as to        how  the rates should    reflect    a 24    reasonable  current cost of fuel.        If the  present Fossil Fuel
 
Adjustment Clause Rider No.      32B were  to remain in effect,      it would be desirable to adjust the kilowatt-hour charges            in  each I
rate rather than to continue the adjustment through Rider No. 35A. It would  also be possible to raise the base cost reflected in the fuel clause      and adjust the charges in the basic rates. This would  reflect  a  lower  roll-in than originally requested    by the Company but would      raise'he    base of the fuel clause    above  its  present level.
In addition to the originally proposed rates        and  adjust-
'0    ment to the  fuel charge roll-in,    I will present    an  alternative method  for the recovery of fuel costs in      excess  of, those 12    reflected in the    base  rates. This alternative method would 13    include  a fuel adjustment clause    based on changes    in  the cost 14    of fuel, including nuclear fuel.        Later in  my  testimony,    I will 15    present the specifics of the development of this fuel adjustment 16    clause and  will present  proposed base rate schedules        that would 17    be necessary    to implement this alternative method of recovering 18    total fuel cost.
19 Q. Is the  Company  proposing or requesting any additional change 20    related to the application of the fossil fuel charge7 21 A. Yes, we are. We would request that the      fuel charge  approved by 22    the Commission in the proceeding be applied to the non-metered sales, including the lighting classifications.          At the present 24    time, the fuel charge only applies to metered sales.            We  have
 
developed an administrative procedure by which the charge can be applied to non-metered      sales on the basis of the estimated kilowatt-hour usage which 'is used in establish-ing  and  reporting sales under the basic rate.      Me  are requesting Commission approval to apply the fuel charge on 6        the basis of    this procedure which    would be consistent with 7        the present practice of the other major      utilities in this 8        jurisdiction.
9  Q. Do  the rate schedules    that you are presenting provide for    a 10        uniform increase    among  the customer classes.
11  A. No, they do  not. The  rate increases proposed in this 12        proceeding are not on an across-the-board      basis, but vary
                            /
13        with regard to recent financial results from the various 14        customer classes. The  re'lative increases to the classes 15        seek to recognize the areas of cost differences        in providing 16      'ervice    and are based  in part  on  the results of our most 17
    "
recent  retail  operations cost allocation study.
18              At the time of the preparation of the rates        filed in this 19        proceeding,  the results of the 1974 cost of service study were
.20        available. These  results which indicated the relative rates of 21        return between the retail rate classifichtions were        used as one 22        of the guides in determining the percentage increase for        each 23        customer class.
 
On  the basis of 1975 sales the average percent increase on the  retail classification    on total  charges,  including fuel revenues,  is approximately  27%. On  the basis of an average 27%  rate increase, there are variations within the various customer classes. The  residential class    will receive  a  total increase of about 32.5%.      This increase  is  a combined    total of the two requests    in this proceeding. The  higher-than-average increase also reflects the fact that the residential class rate of return is below the    retail  average. The  small general 10 service class    will receive  an average  increase of 20.5%.      The lower-than-average    increase  is in recognition of the fact that 12 the rate of return    for this classification is    above the    retail 13 average. The  large general service rates would receive        an 14 increase of  26%,  which  is slightly less than the average retail 15 increase. The  schedules for service to the lighting class of 16 customer  will receive  an average  increase of 16.45%.      This  is 17 the lowest increase that can be applied to the customer class 18 consistent with the receiving of      fair rate of return    from the 19 classification.
20      As a  result of the  Company's  rate history  and  of  its prior 21 marketing policy, which produced very successfully        a  balanced 22 system load with a high growth at a time when those aspects were 23 beneficial to our customers, the      Company has a  relatively large 24 number  of existing rate schedules for    retail service.      A primary
 
objective in our prior rate proceeding          was the  reduction of the number of our      retail  schedules. We  proposed and received Commission approval      to eliminate  a  net of six rate schedules in our prior case.
We  would propose to continue        this  improvement  in our rate structure by the elimination of four additional active rate schedules.      We  are proposing to administratively freeze the  availability of three rate      schedules,    RF-1, AH-1, and SC-1. To  avoid severe financial impacts on the present customers 10 served under these three rate schedules,          we are not requesting the immediate transfer of the present customers to other rate 12 schedules.      We  are proposing instead to      limit the availability of 13 the schedules      to the existing customers and to place        a  higher-than-14 average increase on these rates        in order to  move  the charges into 15 closer alignment with our General Service Rates.              It is  anticipated that over    a  period of time, the customers, because of changing load 17 characteristics      and  differences in the existing rates,        will move  to 18 the general service rates, and        it will be    possible in future rate 19 filings to    complete the process of eliminating these three 20 schedules.
21      We  are requesting the elimination of the House Construction 22 Rate Schedule,      HC-1. This rate provides temporary service during 23 the construction of residential housing units.            We  would propose 24 to replace Rate Schedule HC-1 with our standard Small General 25 Service Rate, G-l, and serve the builder on the general service
 
rate until the permanent service is installed for the residential unit. At the time the permanent service        is installed to the residence,  the residence would then be      billed  on  the standard 4    residential rate for which the residence qualifies.                      This will 5    eliminate the    need  for a  separate rate schedule for service dur-6    ing the time the house is under construction.          This change              will 7    improve our rate administration and I
limit the availability for temporary service to our standard small general service rate.
This proposedprocedure    will have  a  significant financial impact 10    on the  existing  HC-1 customers. The  rates presented in Davis Exhibit  No. 2  containing the modifications described above and 12    others set out therein constitute        a  set of just  and reasonable 13    rates appropriate for our      Company and    the various -types of 14    customers  in our service area.
15 Q. Will you  please describe the manner      in which the  proposed rates 16    recover the fuel expense of the      Company?
17 A. The  rates proposed in this proceeding were designed based                    on a 18    total fuel cost    component  of 1.010 cents per kilowatt-hour.                  The 19    rates were designed during      1975 and    reflected average fuel costs 20    experienced during 1974.      The 1975    test year fuel  expense when 21    annualized for the operation of the Brunswick No.            2          nuclear 22    generating unit is below the fuel cost level designed into the 23    rates originally    filed in this  proceeding. A lower cost of fuel 24    would be more appropriate      in setting rates at this
                                                                    'time.'13-
 
A fuel cost level of '8.60 mills per kilowatt-hour sales is a more  appropriate level to reflect current costs in the design of the rates.
Davis Exhibit No. 3  is a fuel adjustment clause which      we would propose  for the consideration of the    Commission.      As indicated in the exhibit,    we have  established 8.50 mills per kilowatt-hour  as the base cost  for the fuel adjustment clause to include both nuclear    and fossil fuels  and the  effect of purchase and interchange power.      Me  would recommend    this 10    clause to the, Commission to replace the present adjustment clause which recognizes changes only      in fossil fuel costs.
12    Since the base cost of  fuel reflected in this fuel adjustment 13    clause  is below the  level of 1.01 cents per kilowatt-hour 14    included in the original    filed rates, it. is  necessary  to adjust 15    the base rates to which the clause would be applicable.          Davis 16    Exhibit  No. 4 is  a set of alternative rates which have been 17    adjusted to  reflect  the base cost included in the proposed 18    alternate fuel adjustment clause.      These rates are identical 19    to the rates approved for service in our North Carolina territory.
20    Approval of this set of rates and the accompanying fuel clause 21    would return the Company to uniform rates,'throughout        its retail
'22    service area.
23 Q. Did you use the  results of the  1974  retail  cost allocation study 24    in the design of the rates requested in this proceeding?
 
1 A. Yes,  I did. The relative relationship of the rates of return among  the various customer classes,      and,'..to  a  lesser extent, the individual rate schedules,        was used as a guide      in  the distribution of the rate increase        among  the customer classes.
As we have    testified in earlier rate proceedings,          we  are committed toward moving our rate structure and designing our rates in such    a manner as  to produce  a more    uniform rate of return    among  the retail  classes. We  made    considerable pro-gress in our    last rate  case  in applying the increase        such 10    that the rates of return would        move toward    the overall    retail average. We  have attempted    to contine that      movement  in this rate case.
13          It should    be recognized,  however, that there are 14    restraints against      moving  directly to  a  uniform rate of return 15    among  the various customer classes.        These    restraints include 16    the relationship between the individual rate schedules,                the 17    overall revenue requirement        and the revenue      effect  on  individual 18    customers.      It is  necessary  and  desirable to    make  the transition 19    and changes    in the rate schedules    on a gradual and smooth        basis, 20    rather than introduce abrupt changes.            We  tried to design our 21    rates within    all  of those restraints    and make as much progress 22    toward a uniform rate of return as these conditions would allow.
23          Even  without the restraints that exist in abrupt rate 24    changes,    it would  not be desirable to structure our rates to 25    produce a uniform rate of return on the basis of one              test period.
 
This  is true  because  the equal rates of return would be'measured by a  historical test period and      would not    exist when    the rates became effective.      It would not  be  possible to measure the result-ing variation in rates of return      until  the rates had been      in effect  and a  cost study performed at      a  later date. It is  there-fore desirable to set the rates of return within          a  reasonable range rather than seeking absolute uniformity on the basis of a 8    past test period.      In the application of the requested rate 9    increase,  we have  improved the    variation from the      average  retail 10  'ate    of return for each of the customer classes.
ll  Q. Please describe the manner      in which the rates requested in this 12    proceeding were designed.
13  A. The  first step  in the design of the requested rates          was  to 14    distribute the required additional        revenue among the    retail 15    classes on the basis of the results of the          retail  class alloca-16    tion study  and  in proportion to    each class based on      its  percentage 17    of the  Company's revenues.      It was  proposed  in the  case  of the 18    residential class to apply an increase necessary to bring the 19    residential class rate of return to a point closer to the retail 20    average return. It was  likewise concluded to apply less than the 21    average increase to the Small General Service class            in order to 22    continue the movement of the rate of return from that class down-23    ward toward the  retail  average. It was  proposed to apply 'the 24    minimum increase  to the lighting classification necessary to bring 25    the rate of return    slightly  below the    retail  average. Slightly 16-
 
less than the overall average increase        was  applied to the Large General Service      classification.      The  results of these computations were to determine        a  revenue requirement for  each  of the  retail  classes. The rates were then designed within those classes to produce the total revenue requirement, and  to maintain the proper alignment      and    relationship between the rates.
In the case of general service rates, the          most signifi-cant design feature change'as        to incorporate in both small      and 10  large rates which include      a separate demand charge a 12-month seasonal  ratchet to establish the      minimum    billing demand. This 12  design change was    made  to increase the amount charged for        demand 13  in order to create    more  incentive to conserve electricity.
14        The new  billing demand    feature establishes      the minimum 15  billing demand    based on  90%  of the customer's      maximum demand  in 16  the  prior  summer peak months    of July through October.        This form 17  of pricing encourages customers to reduce their            demands  during 18  the  summer peak  period. In addition,  a  billing provision  has 19  been established    as a minimum    of 50%  of the  demands  during the 20  off-peak winter season months;        and as an    administrative iequire-21 ,ment,  .a minimum  of  75%  of the contract    demand  until such time as 22  the actual demand equals the contract demand.            This total ratchet 23  provision enables the customer to control his            billing demand  by 24  reducing his consumption during peak periods.            It establishes  a
 
12-month ratchet rather than the previous provision                    in our schedules. The definition of contract      demand has been'evised in the proposed rate schedules      and service regu-4    lations to conform to the    new  ratchet provision.
5  Q. Have you shown the    results of applying the proposed rates to 6    the individual customer classes?
7 A. Yes,  I have. Davis Exhibit No. 5  presents  a summary            of the 8    results of the cost allocation study indicating the rates, of 9    return for the retail classes that would        have been            realized 10    during the  1974 test year  if the  requested rates had been                          in effect during the entire period.        It should  be noted            that 12    these rates of return are    valid only for comparison of relation-13    ship between the rates and    do not indicate the correct rate of 14    return for )urisdictional ratemaking.        A comparison            of this 15    exhibit with  Horne  Exhibit  No. 2 would    indicate that the 16    proposed rates improve the    variation from the retail average 17    from each of our rate    classifications.
18  Q. Have you shown the    results of the proposed rates'n                  a 1975            test 19    year basis?
20  A. Not on a  retail class basis. The 1975    retail  cost of service 21    study had not been completed and the results were not                    available't 22        the time of the preparation of this testimony.                    The            initial 23    rate design  was based  on a 1974  test period,    and the           results I 24    have shown  for the retail classes are    based on the 1974 cost                          of 25    service study.
18-
 
1  Q. Will you   now  please describe the monetary effect that the proposed rates would have had on the Company's            jurisdictional 3    operation as adjusted had the proposed rate changes been in effect throughout the      1975 test period?
5  A. These  materials are    shown on Davis    Exhibit  No. 6. Column 2
                                                                                \
6    of  Page 1  of this exhibit is identical through Line          25  with 7    Column  7 of Davis Exhibit      No. 1. For convenience,    it restates 8    the actual operating results with appropriate adjustments apportioned to the South Carolina        retail  operations.      Column 3 10      sets forth the effect of the proposed rates had they been in force throughout the test period.          As shown  thereon, the addi-12      tional  revenues would have been about        $ 22,486,985. Additional 13'4 gross receipts, state and federal income taxes arising as a result of these additional revenues,          would have amounted to 15      $ 11,528,321    or 51.27% of the gross revenue increase.            The addi-16      tional net operating      income  for return  would have been 17      $ 10,958,664. Thus, with the increase applicable to South 18      Carolina    retail  sales, the net income for return, including 19      customer growth, would have been         $ 31,055,486,  as shown on 20      Line  18 under Column 4.
21  Q. What  else is shown on Page     1 of Davis Exhibit No. 82 22  A. Lines  19  through 30 show the original cost net investment consisting of net electric plant in service, plus            an allowance 24      for working capital.       The  total original cost net investment is
 
shown on    Line 30. As  stated there, the apparent return in the test year at the present rates would have been 5.98%; and had t
the proposed rates been in effect for the entire test period, this indicated rate of return          would have been 9.27%.
5 Q. What  rates of return would have been indicated in the test year common    equity?
7 A. As  indicated    on Page.3    of Davis Exhibit   No. 6;,the requested rates would have produced        12.18% on actual  common    equity in the test period.       This corresponds    to an allowance in our prior rate 10    order of 12.50%.
ll Q. Is it your     testimony in this proceeding that Carolina Power             &
12   Light     Company   will realize   from the requested     rates   a return 13    of 9.27%   original cost rate     base and 12.18% on       total   book equity?
14 A. No,   it is   not. Mr. Harris and other witnesses have         testified in 15     this proceeding to the fact that         economic conditions       will operate 16    to prevent the     Company   from earning the rate of return allowed 17    by   this   Commiss'ion on a   historical test year basis.
18          Even though the     test year rate of return computations indi-19    cate   a return   on equity of 12.18%, the   Company     will not   have an 20    opportunity to earn that rate of return.           The     rates did not   go 21     into effect in the       full amount   of the increase until March 1, 22     1976.
                                      }}

Revision as of 17:23, 20 October 2019

Carolina Power & Light Company, Application for General Increase in Rates & Notice of Filing Change of Rates - Direct Testimony of Shearon Harris
ML18230A818
Person / Time
Site: Harris  Duke Energy icon.png
Issue date: 06/09/1977
From: Harris S
Carolina Power & Light Co
To:
Office of Nuclear Reactor Regulation, State of SC, Public Service Commission
References
Download: ML18230A818 (102)
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Text

QI RECT TESTiMGNY

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'ate AKGU T Y DOCKET FII.K CAROLINA POWER & LIGHT COMPANY Before the SOUTH CAROLINA PUBLIC SERVICE COMMISSION Docket Nos. 18361 Application for General Increase 18387 ln Rates and Notice of Filing Change of Rates

South Carolina Public Service Commission DIRECT TESTIMONY OF SHEARON HARRIS 1 Please state your name, address and occupation.

2 A. Shearon Harris. My office address is 336 Fayetteville Street, Raleigh, North Carolina, and my occupation is Chairman of the Board, President and Chief Executive Officer of Carolina Power & Light Company (CP&L).

5 Q. How long have you been associated with Carolina Power & Light Company and what positions have you held with the Company?

7 A. I joined the Company in December of 1957 as Associate General Counsel and I became a Vice'President in 1960. I served as General Counsel from the latter part of 1962 until May of 1963 at which time I was 10 elected President. I was designated Chief Executive Officer in January 1969 and in March of 1970 I was elected Chairman of the Board .

12 Would you briefly review some of your experience in the utility industry 13 and in the business community.

14 A. I have served as Chairman of the Edison Electric Institute, which is 15 the trade association of the investor-owned electric utility industry, Chairman of the Board of Directors of the National Association of 17 Electric Companies, Chairman of the Southeast Regional Advisory Committee 18 of the Federal Power Commission, member of the Board of the National 19 Association of Manufacturers and of the Executive Committee of the Business 20 Round Table, and as an officer or active member of various other industry 21 boards and committees. I am presently serving as Chairman of the Executive 22 Advisory Committee for the National Power Survey conducted by the Federal

Power Commission, Chairman of the Electric'ower Research Institute

'\

and serve on the Board of the United States Chamber of Commerce, and as a Trustee of the Committee on Economic Development. I am also a member of the Business Council.

5 q. Would you describe generally the service area, the operating system 6 and electr'ic facilities of CP&L.

7 A. CP&L provides electric service at retail and wholesale throughout a 8 service area of about 30,000 square miles, covering the northeastern r

area of South Carolina much of central and eastern North Carolina 10 and the Asheville area . The population of CP&L's service area is approximately 3,000,000. At the end of March 1975, our retail customers 12 numbered approximately 663,000. About 86 percent of our revenues are 13 from retail service. At the end of 1975 the Company's generating 14 capability was about 6,800,000 kilowatts derived from seven coal-fired 15 steam electric plants, the Robinson nuclear unit, Brunswick nuclear 16 unit No. 2, thirty-three internal combustion turbine generators and four hydroelectric plants. During 1975 the Company's generation by 18 energy source was 72.5 percent coal, 22.4 percent nuclear, 3.8 percent hydro, 19 .1 percent residual oil, .4 percent No. 2 fuel oil and .8 percent natural 20 gas. In 1976 the Company estimates its generation by energy source will 21 be approximately 67 percent coal, 30 percent nuclear, and 3 percent hydro.

22 The capability of our system including net power available on a firm 23 commitment basis is about 7,000,000 kilowatts. We also own and operate.

24 an integrated transmission network and distribution system throughout I

25 the service area. The Company's facilities are interconnected at

various points with the systems of neighboring utilities in order to provide for an interchange of power. Our system and operations are more fully described in the 1975 Annual Report, which is presented here as "CP&L Harris Exhibit No. l."

When was CP&L last granted general retail rate relief for its South Carolina operations?

7 A. The Company was last granted general retail rate relief in South Carolina in a case filed in October, 1973, by order of this Commission dated January 15, 1975 in a proceeding that was based upon a test 10 period ending December 31, 1973.

11 Q ~ What has happened since the rate proceeding to the Company's credit 12 rating?

13 A. In February of 1975 Moody's Investors Services, Inc., one of the nation's 14 major rating agencies, downgraded CP&L's bonds from A to Baa. I know of no 15 other time in the history of the Company that a major rating agency has 16 assessed the quality of the Company's securities as below investment 17 grade.

18 Q Would you elaborate on the effects of the lower bond rating.

19 A. The consequences of this lowered bond rating are far-reaching and 20 continuing. Many financial institutions and investors are now 21 prohibited by their charters or by established policy from investing 22 in CP&L bonds. For example, pension funds for many public employees 5

4 23 are precluded by law from purchasing the Company's bonds as a result 24 of our low bond rating. Some institutions have been precluded from investing in our securities because of the low earnings coverage 26 of fixed charges which has been experienced.

During 1974 hearings in Docket No. 17,134 Company witnesses predicted many harmful results should the Company's A/A bond rating be reduced. The results have been even more adverse than then anti-cipated . At that time, the Company was anticipating a spread between the cost of marketing A and Baa bonds of about 35 basis points. In April of 1975, after the downrating of CP&L's bonds in February, the Company sold $ 100 million in first mortgage bonds at a cost to the Company of 11.24 percent. The most nearly comparable sile by a company with an A/A rating was that of Florida Power and Light Company at a 10 cost of 9.08 percent, 216 basis points lower than CP&L was required to pay. We pointed out in the 1974 case that a Baa rating was 12 certainly not one which would attract investor interest in 30 year 13 bonds. When we attempted in April of 1975 to issue bonds to mature 14 in 30 years, we found that the interest in such bonds rated lower 15 than A by either of the major rating agencies was almost nonexistent.

16 Consequently, we had to shorten the maturity date from the normal 17 30 years to only nine years.

18 We also pointed out in 1974 that a lowering of the Company's 19 bond rating would result in a prompt reduction in the rating of the 20 Company's preferred stock issues imposing substantially higher costs 21 in raising this type of capital. This result has followed and the 22 Company's preferred stock has also been downgraded by Moody's. In 23 March of 1975 the Company sold preference stock at a cost of 11.2 percent.

24 This compared to preferred stock sold in the same period by companies 25 with A ratings for costs in the range of 10.25 percent to 10.36 percent.

26 Our Company was unable to issue preferred stock at that time because 27 of low earnings coverage of preferred dividends and interest charges.

Not only has the lowered"rating resulted in higher costs for long-term financing, it has substantially increased the cost which the Company would otherwise have to pay for short-term financing.

The Company's'ommercial paper rating was reduced from Prime 1 to Prime 2 at the same time the bond rating was reduced by Moody's.

To have its securities rated at below investment grade is exceedingly costly to the Company and its ratepayers and will continue to be so for as long as this lower rating is in effect.

9 Would you please state the objectives of the Company's present rate 10 filing.

ll A. Our overall objective is to improve the seriously deteriorated financial 12 condition of the Company so that we can regain, and once regained thereafter 13 maintain our credit worthiness and continue to provide reliable service to 14 our customers. Nore specifically, we are seeking increased revenues so that 15 (a) the Company's earnings coverage of fixed charges can be restored and 16 maintained at a more reasonable level of at least 2.5 times, (b) a fair and equitable return may be earned on the common equity investment 18 in the Company, and (c) 'the Company can continue the normal maintenance 19 program that was reinstituted after the interim increases of 12 percent 20 became effective on retail sales in the fall of last year.

21 Q. Would you please explain why the Company considers it important that 22 its earnings coverage of fixed charges be increased and maintained 23 at a level of at least 2.5 times?

24 A. Because this is the minimum coverage which in the opinion of the 25 Company will enable its bond rating to be restored to A/A. This is 26 an opinion widely shared in the financial community.

1 Q. Would you please relate the Company's recent coverage experience.

2 A. The Company's earnings coverage of fixed charges fell below 2 times 3 for the 12 months ending October 1974, and notwithstanding the full effect of rate increases (based on 1973 test periods), it continued to remain below 2 times through July, 1975. This compares with earnings coverage of as high as 4.32 for the year 1968. As a resu1t of interim rate relief in the States of North Carolina and South Carolina last fall, the Company's earnings coverage increased to approximately 2.48

.times for the 12 months ending March 31, 1976. This increasing trend 10 is expected to level off soon even though we continue to collect all of our requested increases subject to refund. While our earnings coverage 12 may exceed 2.5 times for a brief period, it can certainly not be 13 maintained there for an appreciable period unless the total rate 14 relief requested in this filing is allowed. It is very important to 15 note that the results for this period. are influenced greatly by the 16 interim increases that have been in effect in North Carolina and 17 South Carolina since last fall and by the full increases sought in 18 both states which have been in effect during some part of that period.

W 19 These revenues have been confirmed by the North Carolina Commission.

20 Should we not be able to recover our full requests here, our effort 21 to regain and maintain our credit rating would be greatly frustrated..

Q. You have stated as a second objective in your rate case an increase in the rate of return to a more reasonable level. Is it your po'sition that the rate of return found fair and equitable in the last rate 4 case is inadequate?

A. I must answer that by first pointing out that because of attrition and a continued high rate of inflation, it has been impossible for the Company to earn the rate of return found by the Commission to be fair and reasonable. The Commission's last rate order, based upon a 1973 test period, concluded that the approved rates should permit 10 CPGL to earn a 12.5% rate of return on its common equity, which rate of return the Commission found to be fair and reasonable. During the 12 year 1975 the Company's actual rate of return on its portion of common 13 equity applicable to South Carolina retail operations was 10 percent.

This is substantially less than the rate of return which the Commission 15 considered as just and reasonable in its order of January 15, 1975.

16 As shown on the Company's revised Exhibit H, when appropriate adjustments 17 are made this rate of return becomes less than 3 percent.

18 A more specific answer to the question is that I do not consider 19 the former rates of return allowed on common equity to be adequate under 20 the circumstances presently existing. In the first place, during the 21 past year it has been possible for purchasers of the Company's debt 22 securities to obtain returns in excess of ll percent. Interest rates 23 on long-term obligations have declined somewhat recently but will 24 undoubtedly return to the high levels of last year as the demand for 25 capital intensifies in the future. It is simply not realistic to

expect to attract equity capital on reasonable terms when the equity investor can from time to time obtain near1y comparable returns on other investments that are not faced with the challenges or the risks that

,

confront the utility industry today.

5 Q, What are some of the risks to which you refer?

6 A. First, I will mention the deterioration that is occurring in the quality of earnings. A debate continues in the financial community over the extent to which earnings containing a high allowance for funds used during construction (AFDC) are of a lower quality than 'earnings that 10 are less dependent upon such allowances. In my opinion, while earnings ll resulting from AFDC are inferior, so long as AFDC does not comprise 12 an unreasonably large proportion of total net earnings the overall quality 13 of earnings is not significantly affected. However, since AFDC provides 14 no cash flow, the risk exposure to investors in a company's securities 15 increases when AFDC accounts for substantially all of the earnings of 16 the company. CP&L has passed that point, and in fact the large amount 17 of AFDC included in CPSL's net income and the resulting small percentage 18 of the Company's cash needs generated internally contributed to the 19 downgrading of its securities by Moody's. A study of the'5 major electrical 20 utilities dated April 29, 1975, by Mitchell Hutchins, Inc., a research 21 firm highly respected in the financial community, showed CP&L as the

22. only Company where AFDC exceeded net earnings available for common stock 23 during the year 1974 . This situation resulted from the large amount 24 of construction work in progress upon which the Company realized no 25 cash earnings.

As of the year end 1974, CP&L's construction work in progress amounted to $ 826 million or 75 percent of net plant in service. By May 31, 1975 construction work in progress,had increased to $ 948 million or approximately 86 percent of net plant in service. Thus, for every dollar of net investment of plant in service, the Company had, approxi-mately 86$ invested in construction work in progress upon which it received no cash earnings.'t the year end 1975, construction work in progress still amounted to $ 643 million, notwithstanding the fact Brunswick No. 2 and related facilities, which accounted for $ 403 million 10 came into service on November 3, 1975.

11 AFDC increased to in excess of 100 percent of net earnings 12 available for common -stock for the 12 months ending November, 1974, 13 constituted 97 percent of earnings available for common for the 12 months 14 ending August, 1975, and continued at an exceptional 79 percent for the 15 12 months ending December 31, 1975. This means that in 1975, without 16 AFDC, .CP&L'had earnings of only $ .57 per share.,

17 The fact that the Company's operating revenues have not been 18 producing sufficient earnings to service common stock is a risk factor 19 which prudent investors must certainly consider in determining whether

20. to invest in our stock or other securities.

21 Q. What are some of the other risks associated with owning electric 22 utility equities at the present time?

23'.

e The delays and changes often involved in the licensing of generating 24 plants are unpredictable and costly. Uncertainties relating to 25 environmental requirements, and potential costs associated with such 26 requirements constitute risks. The more likely probability during .

27 these times of high energy prices and often vocal consumer reaction 28 that governmental or regulatory action (or inaction) will prove harmful

\

is a risk which investors obviously consider. The possibility of adverse governmental and regulatory action constitutes risks which 3 today's equity investors consider.

4 g. What rate of return are you requesting in this proceeding?

5 A. We are requesting rates that would produce additional revenue of 6 '22,486,985 annually. Based upon the 1975 test period, this would yield a return of 12.18% on common equity. Because of attrition and continued inflation, we would expect to actually earn less than 9 this indicated test year return.

10 As our expert, Dr. John Langum, testifies, the Company should actually earn a rate of return on common equity of 14.5%. This is the 12 rate which he finds fair and reasonable and it is also the rate which 13 the Company feels is )ustified. Our original application in this case 14 was prepared to seek a return on equity of this amount. However, subsequent 15 decisions by the Company with respect to the normalization of certain 16 tax deferrals have resulted in a decline in the rate of return which the 17 requested rates would produce.

18 Q. What consequences do you foresee from a failure to obtain the rate 19 relief requested in this proceeding?

20 A. A failure to obtain all of the relief would have serious adverse effects of an immediate and long-lasting nature. Unless our A bond 22 rating is restored by Moody 's, it will be difficult, and perhaps 23 impossible, to raise the amounts of capital required to continue our 24 presently planned construction program. Even if it is regained, it

25. cannot be considered secure without the total increase -requested in 26 this proceeding. Consequently, should we fail to obtain the rate 27 relief requested here, we would have to immediately review our

construction program with a view toward reducing it further. Should we receive significantly less than the total relief requested, our bonds could be downrated even further perhaps to a point'here our ability to obtain capital would be totally restricted. The nation's governmental and corporate debt capital requirements are such that A or lower rated long-term debt funds will be often unavailable at any price. I think it fair to say that should we not regain our A/A bond rating, or should we regain it and fail to maintain it, our ability to raise necessary capital will be impaired to the point that more 10 construction delays will be necessary. Should our bond rating 11 deteriorate to a Baa/BBB the situation would become most perilous 12 and substantial cutbacks in our construction program would immediately 13 follow. Should our rating drop even lower than Baa/BBB, our construction 14 pxogram would come to an immediate halt and mass future shortages of 15 electrical energy in our service area would be assured. There is no 16 'ajor electric utility in the United States which Moody's rates below 17 Baa. Thus, a reduction in CP&L's rating to Ba by Moody's would effectively eliminate the ability of CP&L to raise funds in the capital 19 market.

20 Q. In past rate proceedings, certain intervenors have insisted that rates 21 should not. be raised in order to construct plants for future use. Would 22 you please comment on this position.

23 A. In requesting adequate rates, we are not requesting that today's rate-payer finance plants that will be used in the future. What we-are 25 requesting is that rates be set so that our present costs, including

the cost of a reasonable retuin on capital, be covered. ,The rates which we are proposing are rates which are fair based upon our pr'esent plant in service. No lesser rates would be fair or adequate even if we did not have a construction program., The reason our construction requirements are emphasized is that unless our investors earn a fair rate of return, based upon today's plant in service and today's level of costs, our credit rating will not permit us to borrow .the necessary 8 funds with which to continue construction activities which are

'0 essential in order to have power available in the future.

Q. Will you please briefly review your Company's present construction program.

11 A. Our construction program, which is subject to continuing review, is 12 shown on Harris Exhibit No. 2. During 1975 our construction program 13 underwent substantial downward revisions. It is now tailored to the i~ amount of capital which the Company reasonably hopes to attract assuming l =

15 appropriate rate relief. Based upon present construction plans and the 16 Company's revised load forecasts, the Company's generating reserve margin 17 will drop to 4.9 percent in 1981, a negative 2.4 percent in 1982 and a 18 negative .8 percent in 1983. It will return only to a positive 2.1 percent 19 in 1984.

20 Q. What is the percentage of reserve capacity which your Company is planning?

21 A. Up until 1974 the Company had a goal of 18 percent reserves. This was 22 based upon reserve levels recommended by the Federal Power Commission and 23 considered adequate by the Company. However, during 1974 it became

24 evident to the Company that it would be unable to attract adequate capital 25 to provide these reserve levels. It was therefore necessary to reduce

the level of planned reserves from 18 percent to 12 percent. We anti-cipate no difficulty in meeting this reserv'e criteria thro'ugh the year 1980. As pointed out in my answer to the previous question, however, the Company will be unable to provide even this minimum level of reserves after 1980 if the increases at the rate expected.

j s 6 What is the demand Company's demand forecasts for the next 10 years?

7 A. We expect demand to increase by 7.4 percent annually during the next 10 years. This compares with an annual increase at a compound rate of 10.4 percent over the 10 years ending in 1974. It is obvious that 10 the construction now planned by the Company is a minimum construction program which will not maintain the Company's 12 percent reserve goal 12 in certain future years unless the growth in demand increases by no 13 more than an average of 6.5 percent over the next 10 years.

14 Q. Could it be that your growth forecasts are in excess of what should 15 reasonably be expected?

16 A. Our forecasts are based upon two studies one conducted within the 17 Company, and one conducted by a highly qualified outside consulting 18 firm, Whereas, in past years we have tended to approve a mid-range 19 of the upper and lower forecasts that have been proposed, our latest 20 approved forecast accepts the lowest rate of growth suggested as 21 probable by the studies. It would certainly seem imprudent to ignore 22 what these studies tend to show. In August of 1975 we had a peak 23 demand of 5060 megawatts, which is in excess of the 5001 megawatts 24 we were projecting for 1975. It is the peak demand that determines the 25 amount of capacity which we must have available.

1 e. What growth are you experiencing in KWH sales' 2 A. Our sales growth was slower in 1975 than expected although with

3. respect to certain classes of customers it was in line with our projections. As I have pointed out, our peak demand forecast did turn out to be conservative.

What" has been your sales increase to date in 1976'?

7 A. Through March of 1976, usage by our customers increased by almost 13% over that of the first quarter of 1975; Should this continue, our 1976 sales forecast would prove overly conservative.

10 q. How has your Company's load factor been affected by recent kilowatt-ll hour sales experience?

12 A. As peak demands have continued to increase while kilowatt-hour sales 13 remained relatively flat, we have seen a natural deterioration in our 14 load factor. This has not been in the interest of the ratepayer or'he 15 . Company.

Would you please describe your Company's future capital requirements.

17 A. Although our construction program has been reduced considerably, the 18 capital requirements remain enormous. $ 6.3 billion will be required over the next 10 years. $ 826 million is necessary for the years 20 1976-78, and a substantial portion of this must be raised through the 21 public sale of capital stock and first mortgage bonds.

22 As a result of inadequate earnings, the Company's last three 23 common stock issues had to be sold below book value. This means that

37 percent of the common shares now outstanding has been sold below 2 book value and although there has been an improvement in the price of 3 our stock as the stock market generally has improved, it continues to sell below book value. The dilution in the value of common stock owned by investors at the time of those sales has been substantial.

The Company must again sell common stock in the fall of this year.

Should these applications not be allowed in their entirety, and should the Company be forced to make refunds of amounts already collected, we would not expect a successful stock sale.

Mr. Harris, one of the three objectives of this rate case,'hich you mentioned at the beginning of your testimony, was that the Company be 12 able to continue normal maintenance. Would you elaborate on this, please.

13 A. Yes. A part of the rate increase requested is to continue our normal maintenance program which we were able to reinstitute after interim 15 retail increases became effective last fall. Normal maintenance 16 is now underway pending the outcome of this general rate request.

17 Unless all of the relief requested in this fi.ling is a11owed, it wil1 18 be necessary for us again to defer some maintenance expenditures.

Why did your Company ever depart from what you term a "normal maintenance 20 program"?

21 A. ln 1974 it became apparent that the rate relief sought in applications 22 filed in October 1973 would not be sufficiently timely nor adequate to restore earnings to a level where the Company's securities would be

attractive to investors and could be sold on reasonable terms. Consequently, in order to preserve the Company's financial integrity and to be able to continue to finance its construction program, we went beyond our on-going cost control program and inaugerated an emergency expense curtailment program, which was designed to delay or eliminate costs. This program was called to the Commission's attention during testimony in rate hearings in 1974. The program eliminated some reasonable and proper expenses and deferred some essential expenditures pending an improvement in the 9 Company's financial condition to a point .where its A bond rating would 10 be less insecure and it could market common stock and other securities on reasonable terms. However, notwithstanding vigorous cost reduction 12 efforts the Company's coverage of fixed charges dropped below 2 times to 1.92 times at year end 1974. In February 1975, the Company's bond 14 rating was reduced from A to Baa by Moody's Investors Services, Inc.

15 and we have not recovered financially to a point where delayed

'I and 16 badly needed expenditures can be resumed without further threat to 17 our financial stability. In early 1975 it became necessary to further reduce our level of maintenance to partially compensate for revenues 19 lost when the North Carolina Commission restricted collections under 20 the fuel clause, and for the further purpose of attempting to raise 21 our earnings coverage of fixed charges to a level where we could continue 22 to market securities without having to pay exorbitant prices. That 23 level of maintenance continued until our interim retail rate increases 24 were placed into effect last year.

1 Q. To what do you attribute your Company's present financial condition and the fact that it has been unable .to earn the rates of return allowed by this Commission?

4 A. There are four major cost factors, all of which are beyond our ability to absorb or defer, that have led to our present depressed financial condition. The first factor is a continuing high rate of inflation which affects electric utilities to a greater extent than industry generally. Our present rates, as the Commission is well aware, were based upon costs in a 1973 test year.

10 A second factor which I will mention and a most major factor is the cost of capital. The cost of capital obtained on a long-term 12 basis has continued to increase. The $ 100 million in First Mortgage 13 Bonds which we issued in April of 1975 was at a cost of 11.24%.

14 This compares to an average cost for bonds issued in the former test year of 1973 of less than 8%. At the end of the last test period, 16 the average interest rate of, the Company's First Mortgage Bonds was 17 ~

6.78%. By December 31, 1975 this had increased to 7 .72%. On December 31, 18 1973 the average dividend rate on preferred stock was 7.24% on the 19 preferred stock outstandin g. In March of 1975 we issued preference 20 stock at a cost to the Company of 11.21%. As I have previously mentioned, 21 we were unable to issue preferred stock at this time because our earnings 22 were insufficient to meet the earnings coverage requirements of our 23 charter. The average dividend rate on preferred and preference stock 24 is now 8.06%, having risen 11% over the average dividend rate on 25 December 31, 1973. The cost of servicing common equity has 'also

increased significantly as we have been forced to sell additional common stock at below its book value. En our last rate case, I testified that in November, 1973 we were required to sell 3,000,000 shares of common stock at a "distressed price." That stock sold for

'$21.25 per share, and netted to the Company proceeds of. $ 20.31 per share after underwriting discounts. Since that time, we have sold 4,000,000 shares of common stock "in January 1975 at a price of

$ 14.75 per share, 31% less than the $ 21.25 per share of,the November 1973 issue. The net price was'nly $ 14 .00 per share.

10 In October 1975 we sold 5,000,000 shares of cpmmon stock at $17.'875 a share, 23% less than the $ 23.34 book value. The net price was only $ 17.215 a share.

13 A third factor has been expenditures which we have made," and are continuing to make in increasing amounts, for environmental protection..

15 Since the beginning of 1972, we have invested over $ 84 million in 16 devices to protect -air and water. We are spending about $ 30 million 17 annually for systems that do not add to our capacity indeed many 18 use substantial quantities of energy. Consequently, the cost we 19 experience is not limited to the cost of servicing the capital required 20 to install the systems and devices; our cost of producing electricity for sale increases since a portion of our gener'ation must be used to

22. operate some of the environmental devices. We simply cannot absorb

the tremendous costs involved . When we filed our last rate case, in October of 1973, we firmly believed that the cooling system then planned for the Brunswick Nuclear Plant was not only adequate, but was acceptable to state and federal regulatory authorities. Since that time, we have been ordered to install cooling towers at a cost of over $ 72 million. We are attempting to avoid this requirement as we feel that it is a useless expenditure of the Ielectric consumers money.

However, it has been necessary for us to beginiconstruction of the cooling towers, and whatever costs are ultimately incurred will have to be 10 recovered through increased rates.

ll A fourth major factor is attrition. Cost of building power plants 12 and other facilities has increased dramatically, and as new facilities are brought on line and into the rate base, it is necessary that costs associated with them be recovered . The cost of our Robinson Nuclear Unit completed in 1971 was about $ 127 per kilowatt capacity. Our Brunswick No. 2 plant, which entered commercial operation in November of last year cost about $ 485 per kilowatt capacity. While decreased 18 fuel costs associated with this nuclear plant means lower overall 19 rates to the consumer than would be possible with other forms of 2O generation, the capital and other fixed costs associated with this n generating plant have to be recovered through increased base rates. As 22 new and more expensive facilities become a part of the Company's rate 23 base, the capital and other fixed costs associated with generating 24 electricity increases accordingly.

What action has your Company taken to reduce its expenses?

2 A. The Company continues a vigorous cost control earnings improvement 3 program which eliminates or defers expenses for items that are necessary 4 and proper business expenses in the sense that they are desirable and 5 reasonable but are of the nature that they can be postponed indefinitely 6 or delayed. As a part of its regular business practice the Company 7 has always maintained a cost control program in every department, and the prevention of unnecessary cost has always been an item of top priority with the Company's management. The commitment of the Company to "frugality" is well known to all who have ever been associated with ll its operations. The expense curtailment program which is now in 12 effect, however, goes beyond the Company's tradition of austerity.

13 For instance, no new personnel may be employed without the specific 14 approval of me as Chief Executive Officer. I do not approve the 15 filling of any vacant positions unless it is demonstrated that the I

16 new employee is absolutely essential in order to assure that necessary 17 tasks can be carried forth. Budget restraints have been imposed 18 on all departments. Moreoever, we have organized within the 19 Company a Corporate Performance Review Department. Among its 2O duties is the responsibility of analyzing the performance of 21 the various facets of our Company's operation and comparing them 22 with those of other companies. If other companies are out-performing 23 CP&L in any area, the responsibility of this Department is to 24 determine why. If any other similarly situated company is doing efficiently at less cost than this

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25 anything more and Company, we

want to know about it and can assure'he Commission that we wi11 implement any changes necessary that might improve our performance 3 even further.

4 Q. Is your corporate analysis far enough along to give any indication

'5 of how your Company compares with other similarly situated companies?

6 A. Yes indeed.'ur total operations compare most favorably with those of the industry generally and with eight similar southeastern investor-owned companies with which we have made comparisons. For instance, the Company's total operating expenses and interest charges per kilowatt-hour of energy sold was less than that experienced by six of the other 10'1.

seven comparison companies during the year 1974. Stated another way, we 12 delivered more kilowatt-hours per dollar of total operating expenses 13 and interest charges than did all but one of the other comparison 14 companies. A study of the 50 largest investor owned electric utilities 15 in the country shows that while CP&L was 28th from the largest customer 16 wise, in 1970, 26th in 1971, and 25th in 1972, its operations and 17 maintenance expenses per kilowatt-hour sold were "32d. from the highest 18 in 1970, 34th in 1971, and 39th from the highest in 1972. Complete 19 ~

figures are unavailable for subsequent years at the present time; 20 however, we believe that the trend is continuing.

21 Q. Are you familiar with the recent comparison study of electric utilities 22 released by the National Association of Regulatory Utility Commissioners?

23 A. Yes. Me have received copies of the report and have analyzed it. It confirms our own studies and shows that our Company compares most 25 favorab1y" with other companies. in every area studied.

1 Q. Would you have any objection to a management audit of your 4

Company 2 by an outside consulting firm?

3 A. None whatsoever. I have stated publicly on any number of occasions that we would welcome such an audit. The North Carolina General Assembly has authorized the North Carolina Utilities Commission to order audits once every five years with the expense being paid by the companies and recovered through rates. The Commission has recently employed the firm of Booz, Allen and Hamilton to conduct a review of our Company and I would expect this firm's findings to be made available to the South Carolina Commission and to the 10 public . By the time we have hearings in these proceedings this review 11 should be well underway. We are confident that the audit will reveal that 12 we are managing efficiently.

Is your Company asking for a continuation of the fuel clause?

14 A. Yes. The details of our recommendations are contained in the testimony of other witnesses.

Q. Do you consider a continuation of the fuel clause necessary in view of the fact prices have stabilized?

18 A. By all means. Fuel costs comprise such a large portion of our operating 19 expenses that even slight fluctuations amount to tremendous sums of money .

20 If the fluctuations are downward the customers should receive the benefits.

21 If they are upward, the Company must cover its cost. Moreover, we are 22 sta.ll subject to immediate and extreme upward fluctuations in fuel prices 23 which cannot be accommodated through traditional forms of rate hearings.

Finally, the introduction of larger percentages of nuclear generation on 25 our system means that monthly costs of fuel will vary significantly even

if fuel prices remain level. This is because nuclear fuel is so, much less expensive than fossil fuel. In months when we get substantial

'1 nuclear generation fuel cost will be down. However, in months when nuclear plants are out for refueling or sub)ect to other outages fuel costs will increase appreciably. We are of the firm opinion that a fuel ad)ustment clause is a fair and equitable means of compensating 7 for fuel cost fluctuations.

Q. Mr. Harris, would you please summarize your testimony.

9 A. My testimony essentially is that notwithstanding rate relief previously 10 granted by this Commission, the level of earnings of the Company remain 11 significantly below what the Commission has previously determined fair 12 and reasonable. This means that CP6L is not recovering all of its costs 13 and its financial integrity is continuing to decline. In order to 14 continue our "bare bones" construction program, it is absolutely essential 15 that our bond rating be restored by Moody's at the earliest possible moment.

'

16 For the bond rating to be restored and maintained, it will be necessary that 17 our coverage of fixed charges improve to a level of at least 2 1/2 times 18 and be maintained there for an appreciable period of time. Without rate 19 relief, we would expect the amount and quality of our earnings to decline 20 dramatically, especially as new plant comes into service. Without rate 21 relief which we now request, our bond rating will be sub)ect to further

/

22 deterioration and drastic cuts will have to be made in what is already 23 a "bare bones" construction program. Beyond any question, unless we obtain 24 the rate relief requested in this application, the Company's ability 25 to continue to provide service efficiently to its customers will 26 ultimately suffer.

South Carolina Public Service Commission CAROLINA POWER & LIGHT COMPANY DIRECT TESTIMONY OF EDWARD G. LILLY, JR.

1 'Q Please state your name and business address.

2 A. Edward G. Lilly, Jr., 336 Fayetteville Street, Raleigh, Noith 3 Carolina.

4 Q. What is your position with Carolina Power & Light Company?

5 A. I am Senior Vice President-Finance of the Company.

Q..Please describe your educational background and business 7 experience.

A. I am a graduate of Davidson College where I received a degree 9 of Bachelor of Science in Economics. I hold a Master of 10 Business Administration degree in Banking and Finance from the Wharton School of Finance at the University of Pennsylvania.

12 I am a graduate of the Executive Program of the University of 13 North Carolina and I have completed the Irving Trust Company 14 Public Utility Finance Seminar. I am a member of the Executive 15 Committee of the Edison Electric Institute Finance Committee.

16 From 1952 to 1971 I was associated with Wachovia Bank and 17 Trust Company, where I held various positions which 'were related 18 principally to financial analysis, handling loans for corporate 19 customers and administration. From 1963 to 1970 I served as 20 Senior Vice President and Office Executive of Wachovia's banks 21 . in the Durham area. During 1970-1971 I served as Manager of the

Investment Services Department at Wachovia's headquarters in Winston-Salem. In March 1971, I became associated with Carolina 3 Power & Light Company as Senior Vice President-Finance.

4 Q. Please describe your duties as Senior Vice President-Finance of 5 Carolina Power & Light Company.

A. I am the senior financial officer of the Company and as such I am 7 responsible for the long-term and short-term financing programs 8 of the Company. I have responsibility for planning and implement-ing the issuance, sale and servicing of first mortgage bonds, 10 preferred stock, common stock and any other securities issued by the Company, as well as short-term financing arrangements of the 12 Company including the negotiation of bank loans an'd commercial 4

13 paper. In addition, I am responsible for developing and maintain-14 ing the Company's investor relations program with the financial 15 community. I have overall responsibility for the treasury, 16 accounting, computer services, purchasing and internal auditing 17 functions of the Company, including preparation of budgets and 18 forecasts and all financial statements issued by the Company. My 19 responsibility also includes the management of Company funds to 20 insure that the Company has available at all times sufficient cash 21 to pay its expenses of operation and to meet its payments for con-22 struction work.

Please state the nature and scope of the testimony which you will 24 offer.

25 A. This testimony will relate to the Company's financing plans which 26 must be implemented in order to obtain the funds necessary to meet

the tremendous challenge facing the Company of constructing sufficient generating and other necessary facilities to meet the needs of our customers and to the problems facing the Company in 4 the undertaking of this financing.

Q. Will you please explain the Company's financing plans?

A. Despite the emphasis on energy conservation which has been stressed 7 by the Company for several years,'he electric energy demands of 8 our service area continue to grow to such an extent that the 9 Company's planned construction expenditures for the next 10 'years 10 will amount to approximately $ 6.3 billion. In the first quarter of this year, energy demand rose 13 percent over the same period 12 last year. We anticipate that approximately $ 4.0 billion of this 13 amount must be financed through the attraction of new capital to 14 the Company from the sale of securities in the financial market, 15 an amount unprecedented in the history of Carolina Power & Light 16 Company. The impact of this program is brought into focus by 17 comparing the additional $ 6.3 billion plant investment with the 18 Company's net plant account of $ 2.2 billion at year end 1975.

19 Looking to the immediate future, the Company's construction expendi-20 tures for the years 1976 through 1978 are expected to amount to 21 $ 826,000,000.

22 In order to finance this three-year construction program, the 23 Company must raise a substantial portion of the $ 826,000,000 by 24 the attraction of additional capital to the Company. These funds 25 can be obtained only through the sale of the Company's securities 26 to willing investors in the open market. The Company now has

~ 1 about 91,000 shareholders. Over 39,000 of them, or approximately 43%, are located in the Carolinas. We cannot expect investors to continue to invest their savings in our Company unless we can earn'n adequate rate of return on such investment and provide satis-5 factory dividends.

6 Q. How does the Company plan to secure funds to meet its construction 7 program for the years 1976-19782 8 A. A portion of the required funds will come from retained earnings, charges to depreciation and deferred income taxes. However, a major 10 portion of the funds must be obtained by the sale of additional securities of the Company. We must sell new securities in sub-12 stantial amounts each year.

13 A brief review of the securities offered to the public by th' 14 Company during 1975 illustrates the cost penalties which must be 15 borne by the Company and its customers as a result of an unsatis-16 factory financial condition.

17 During January 1975, it was necessary for the Company to sell 18 common stock in order to attract capital and to improve the common 19 equity ratio of the Company which had fallen to a low level of 20 less than 30%. The Company sold 4,000,000 shares of common stock 21 which resulted in a net'rice to the Company of only $ 14 per share, 22 which was approximately 60% of the book value of the common stock 23 at the time of the sale. Obviously, such a sale of common equity 24 is extremely unsatisfactory and substantially dilutes the value of 25 the shares of common stock previously held by the Company's share-26 holders.

During March 1975, the Company would like to have sold preferred stock. However, because of the continued decline in earnings avail-able for interest and preferred dividends, the coverage ratio for interest'ayments and preferred stock dividends had been reduced to the level where the Company did not meet its required Charter test

'to market preferred stock. Thus, it was necessary for the Company to sell preference stock, a junior security to preferred stock, in order to attract needed capital. Since the preference stock was basically unattractive to institutional investors, it was necessary to offer 10 the stock at a 925.00 issue price, as opposed to the $ 100.00 issue price which had previously been used by the Company for distribution 12 of preferred stock, thus substantially increasing the distribution cost. The net cost to the Company for the funds obtained through 14 the sale of preference stock was 11.17%, the highest rate ever paid 15 by the Company on preferred or preference stock.

16 During April 1975, the Company offered $ 100,000,000 of first '7 mortgage bonds. Since the Company was utilizing the fund's to finance 18 generating and other long-life equipment installed for the benefit 19 of its customers, the Company wished to sell bonds with a maturity 20 of 30 years. However, as a result of the bond rating of the Company 21 having been reduced from A to Baa by Moody's Investors Service, 22 because of the unsatisfactory earnings of the Company resulting in fixed charge coverage of less than 2.0 times, it was not possible 24 for the .underwriters to market 30-year bonds on any satisfactory 25 basis. Thus, the maturity of the bonds had to be reduced to nine 26 years and sold at a net cost to the Company of 11.24%. This cost

was the highest cost the Company had ever experie'need in connec-tion with its first mortgage bonds.

During the fall of 1975, the common equity ratio of the Company was again at an extremely low level of less than 30% and thus it was necessary for the Company again to sell common stock in order to attract capital and improve the common equity, ratio. The Company 7 sold 5,000,000 shares of common stock during'October 1975 at a net 8 price to the Company of 917.215 per share or approximately 75% of 9 'ook value. Again, this sale of common stock resulted in additional 10 substantial dilution to the present shareholders of the Company.

During the years 1976-1978, the Company will need to sell sub-12 stantial additional amounts of securities. The exact timing and 13 types of securities sold will be influenced by the ability of the 14 Company to meet coverage ratio tests and maintain a reasonable capital 15 structure, as well as the conditions of the securities markets during 16 those years. One of the major problems facing the, Company is the 17 need for continued sales of large amounts of common stock, which the 18 Company needs to sell at prices above book value.

19 Q. What, if any, other problems do you feel the Company faces in 20 carrying. out this financing program?

21 A. Historically, the Company has raised capital for its construction 22 program through the sale of first mortgage bonds, preferred stock 23 and common stock. Let me examine briefly the current situation 24 relative to the Company's ability to issue such types of securities.

25 First Mort a e Bonds 26 Table I listed below shows the average cost of outstanding

bonds at the end of each of the past ten years and at June 30, 1975. As recently as December 31, 1969, the average cost of 3, all bonds outstanding was 4.72%. This, average cost has increased with the sale of each issue of bonds by the Company and had reached 7.72% by year end 1975, an increase of 63% during the six-year period.

TABLE I 8 End of Year Embedded Cost Year All Bonds 10 1966 4.04 1967 4.40 12 1968 4.72 13 1969 4.72 14 1970 5.64 15 1971 6.14 1972 .6.40 17 1973 6.77 18 1974 7;29 19 1975 7.72 20 The ability of the Company to acquire capital through the 21 sale of first mortgage bonds at a competitive interest rate is 22 principally determined by the rating which the first mortgage 23 bonds of the Company are assigned by the major bond rating 24 agencies. As a result of declining earnings and thus declining 25 fixed charge coverage ratios, the first mortgage bonds of the 26 Company were downrated during 1971 by both of the major rating

agencies from AA to A. Fixed charge coverage ratios declined further during 1973 and 1974 and by December 1974 had dropped to the dangerously low level of 1.92 times. Moody's reduced first mortgage h

4 the rating on the Company's bonds to Baa, further aggravating the ability of the Company to raise needed capital.

During the second half of 1975, principally as a result of the addition of revenues collected, subject to refund, under South Carolina and North Carolina interim rate increase orders and a wholesale rate increase order from the Federal Power Commission, 10 the Company's fixed charge coverage improved slightly to 2.27 times by year end 1975. However, we feel it absolutely necessary for the fixed charge coverage ratio to increase to a minimum of 2.5 times 13 and to remain somewhat above that level in order for the Company 14 to retain its A bond rating and to hold such a bond rating.

Table II lists the year end fixed charge coverage ratios of 16 the Company, as calculated under the Securities 6 Exchange formula, 17 . for the past 10 years.

18 TABLE II

.19 Year "

Fixed Char e Covera e Ratio 20 1966 5.16 21 1967 4.87 22 1968 4.32 23 1969 3.38 24 1970 .2. 25 25 1971 2.50 26 1972 2.90, 27 1973 2.34 28 1974 1.92 29 1975 2.27

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As shown, as recently as December '31, 1972, the fixed charge coverage ratio was 2.90 times, but had declined to 1.92 times as of December 31, 1974, a decline to a dangerously low level. While the collection of "subject to refund" revenues allowed under interim rate orders and the receipt of a rate order making permanent all revenues collected on North Carolina retail sales has resulted in an improvement in fixed charge coverage during recent months, as of the time of the preparation of this testimony, the Company still has not received a restoration of its A bond rating from Moody's Investors 10 Service. If the coverage of fixed charges does not continue to 11 improve in the near future, the Company risks not only a continuation 12 of the Baa rating assigned by Moody's, but a downgrading of the A 13 rating presently assigned by the other major bond rating agency.

14 Q. What effect has the reduction of the rating on the Company's bonds 15 from A/A to Baa/A had upon the Companyf ~

A. T1ie reduction of the rating on the Company's first mortgage bonds 17 to Baa/A has had three major negative effects upon the Company.

18 First, the reduction in rating requires that the Company pay a 19 substantially higher cost in order to sell its bonds. In his 20 testimony, Mr. Shearon Harris has pointed out that in April 1975, 21'2 after the downgrading of CP&L's bonds, the Company sold $ 100,000,000 first mortgage bonds at a cost to the Company of 11.24%. The next 23 sale of a comparable size issue with a comparable maturity by an 24 electric utility company with an A/A rating occurred a short time 25 later when Florida Power & Light Company sold $ 100,000,000 of first 26 mortgage bonds at a cost of 9.08%, 216 basis points lower than the

cost CP&L was required to pay. While the difference in cost between a Baa/A bond and an A/A bond will vary, it is expected that the cost differential generally will be high.

Since CP&L utilizes most of the funds obtained from the sale of first mortgage bonds to pay for assets with an expected life of 25 years or longer, it has been the practice of the Company to sell bonds with a maturity of 30 years. Unfortunately, the CP&L

'I bond rating of Baa/A was not sufficiently high to attract investors to a 30-year maturity at the time of the 'last bond sale and thus 10 it was necessary for the Company to sell bonds with a maturity of only nine years. Such action, 'of course, indicates that the risk 12 of additional financing and the expense of additional financing 13 must be met during the expected life of the assets.

14 Second, a reduction in bond rating has eliminated certain sources 15 of funds to the Company; that is, many institutional investors and 16 large individual investors as a matter of policy or of legal limita-17 tion will not purchase a bond with a rating below A/A. For example, 18 pension funds for the employees of the States of South Carolina and 19 North Carolina may no longer be invested in bonds presently being 20 offered by CP&L. Such restrictions of the market in which the 21 bonds of the Company are sold increase greatly the difficulty of 22 marketing the Company's bonds at any reasonable interest rate.

23 Third, the reduction from the A/A rating of the Company's bonds also has had a substantial adverse impact upon other financing costs 25 of the Company. At the time Hoody's reduced the Company's bond 26 rating, it also reduced from A to Baa the rating on the Company's lo-

preferred stock and reduced the rating on the Company's commercial paper from Prime 1 to Prime 2. The Prime 2 c'ommercial paper rating has resulted in the Company's cost for these short-term borrowings increasing by 50 to 75 basis points. (i.e., 6.00% to 6.50% or 6.75%). The rating assigned to a Company's first mortgage bonds is in effect the "key rating" to which other securities and borrowings

~

of the Company are related. The fact that CP6L's securities are now rated below investment grade has had a substantial adverse impact upon the cost of long-term and short-term securities'ssued by the 10 Company, as well as any lease financing or other types of financing which the Company may utilize.

12 Preferred Stock 13 Q. Please comment upon the difficulty, if any, of selling preferred I

14 stock.

15 A. Table III lists the average cost of preferred stock of the Company 16 at the end of each of the past 10 years.

17 TABLE III Weighted 18 Year 19 1966 4.72, 20 1967 5.06 21 1968 5.06 22 1969 5.06 23 1970 6.46 24 1971 6.91 1972 7.17 26 1973 7. 24 27 1974 7.54 28 1975 8.06

Here again, it is noted that as recently as December 31, 1969, the average cost of preferred stock was 5.06%. As of December 31, 1975, this cost had increased to 8.06%, an increase of 59%. As was discussed earlier, during most of 1975, the Company, because of reduced earnings available to pay interest and preferred stock dividends, did not meet its Charter require-ments for the issuance of additional preferred stock. Thus, the Company simply was in a position where it could not issue preferred stock and had to resort to other, more expensive, sources of 10 capital. In March 1975 it was necessary for the Company to issue preference stock, a class of stock rated junior to preferred stock,-.

12 at a cost to the Company of 11.17%. The cost of issuing preferred 13 or preference stocks with ratings .lower than A/A was quite high 14 during 1975. For example, during September 1975, Indiana Michigan 15 Electric Company sold an issue of preferred stock with a rating of 16 Baa/BBB at a cost to the Company of 12.75%. It is noted that the 17 rating obtained by Indiana Michigan Electric Company was above the

'I 18 rating which could have been obtained on CP&L reference stock.

19 Since preference stock is a junior issue to referred stock, the 20 rating agencies normally assign a rating to preference stock one 21 rating below the rating assigned to preferred stock.

22 Again, the collection of additional revenues, which are subject 23 to refund as aLlowed by interim rate increases, has allowed the Company's earnings to improve sufficiently to meet the Company's 25 Charter requirements for'he issuance of preferred stock provided 26 such revenues are made permanent by the appropriate regulatory 27 authorities.

12-

Common Stock 2, Q. Please comment upon the common equity ratio of the Company.

3 A. It is vitally important that the Company, be able to sell common stock successfully. Common stock is the foundation upon which senior capital financing rests.. The bond holder -and other senior capital holders look to an adequate common stock equity base for protection of "their investments. Thus, the common equity ratio of the Company is extremely important in determining the Company's continued ability to sell senior securities. The goal of the 10 Company is a common equity ratio of approximately 35%. The long-term financing plans of the Company are designed to achieve this 12 goal. However, after the sale of two issues of common stock 13 totaling 9,000,000 shares during 1975, the common equity ratio of the Company is less than 33% and thus the Company will need to sell 15 additional common equity in the near future. While general financial 16 market conditions have improved and the market price of CP&L common 17 stock has also improved, the stock of the Company still has a 18 market price below book value.

19 Q. Does the Company experience any significant difficulties in attract-20 ing common equity?

21 A. During 1965, the common stock of CP&L sold at $ 52 per share. During 22 late 1974, the common stock of the Company sold below $ 11 per share 23 or at less than 50% of book value. Table IV shows the relationship

24. of the sales price of common stock to the book value per share for 25 the last four sales of common equity by the Company.

TABLE IV Percentage

~ Above or Date of Number Net Price Book Below Book Sale of Shares Per Share Value Value ll/9/72 2,500,000 28.05 21.16 32.6 11/15/73 30000,000 20.31 23.25 (12.6) 1/16/75 4,000,000 14.00 ,.23. 35 (40. 0)

.10/28/75 5,000,000 17.215 (25.6)

The rapid and sharp reduction from the ability to sell common equity at more than book value to the necessity to sell at prices 10 substantially under book value is having a severe impact upon the ability of the Company to attract common equity on any reasonable 12 .basis.

13 When the stock of a company is selling below book value, a 14 greater number of shares is required to be issued in order to obtain 15 a given amount of equity capital. This action results in additional 16 dilution in the existing shareholder's equity and a dilution in his 17 future earnings per share. Such action further depresses the market 18 price of the existing stock, thereby increasing the cost of equity 19 and debt financing to the Company and making it 'even more difficult 20 for a company to finance on any reasonable basis.

21 Q. Are there other factors which add to the difficulty which the Company 22 experiences in raising the funds necessary to meet its construction 23 responsibilities?

24 A. Yes, the substantial percentage of earnings of the Company .which 25 result from allowance for funds used during construction has had a 26 serious adverse impact upon the securities of the Company in the

financial markets. Table V lists the amount and percentage of net income available for common stock that is composed of allowance for funds used during construction for the years ended December 31, 1969 through December 31, 1975.

TABLE V Allowance For Funds Net Income Allowance For Used During Construction After Preferred Funds Used During As % of Net Income 7 12 Months Ended

  • 1969 24,418,000 4,397,000 "'ecember 18.0 9 December 1970 20,126,000 10,505,000 52.2 10 .December 1971 29,103,000 14,708,000 50.5 December 1972 50,917,000 24,759,000, 48.6 12 December 1973 52,982,000 38,093,000 71.9 13 December 1974 51,599,000 54,609,000 105.8 14 December 1975 75,870,000 59,957,000 79.0 15 Q. Please explain the changes in this percentage and the significance 16 of these changes to the Company.

A. During the year 1969, only 18% of the net income available for common 18 stock was a result of allowance for funds used during construction.

19 This percentage increased rapidly to a level of approximately 50%

20 during the period 1970 through 1972. During the years 1973 through 21 1975, the percentage again increased sharply averaging approximately 85% during the most recent three years. It is noted that during the year 1974, allowance for funds used during construction actually 24 exceeded net .income available for common stock. Regardless of the 25 current accounting treatment of allowance for funds used during 26 construction as "nonoperating income," the amounts are not revenues

- 15

received from the sale of electricity. When allowance for funds used during construction is excluded from the calculation for fixed charge coverages, the ratio for the year ended December 1975 drops from 2.27 times to an alarming level of 1.67 times.

This situation results from the large amount of construction work in progress upon which the Company realizes no cash earnings.

On average during 1975, construction work inprogress amounted to

$ 886,000,000 or approximately 75% of net plant in service. Thus, for every dollar of net investment of plant in service, the 10 Company had approximately 75C invested in construction work in progress upon which it did not receive any cash earnings. Mitchell, 12 Hutchins, inc., a highly regarded research firm in the financial 13 community, conducted a study of 45 major electric utility companies 14 during April 1975. This study shows CP&L as the only company where 15 allowance for funds exceeded net income for common stock during the

'16 year 1974. Such a condition obviously causes grave concern in the 17 minds of investors as to the financial soundness of a company.

1 18 g. Mr. Lilly, please summarize the factors,to which you have testified 19 which cause difficulty in attracting capital to meet the Company's 20 construction expenditures.

21 A. ~e financial condition of the Company deteriorated rapidly during 22 1974 and 1975. Fixed charge coverage fell to extremely low levels.

23 resulting in a reduction in the ratings of the Company's first 24 mortgage bonds, preferred stock and commercial paper. The percentage 25 of net income available for common stock represented by allowance 26 for funds used during construction h'as increased rapidly and during

1974 allowance for funds used during construction actually exceeded total,net income available for common stock. The cost of attracting capital to the Company has continued 'to increase and remains at a high level.

These factors, when combined with a return on common equity of an amount less than the earnings level which this Commission has previously found to be fair and reasonable, have resulted in the necessity of the Company selling additional common stock at prices below book value. The selling of common stock below book 'value further aggravates the serious financial condition of the Company.

Without the interim rate increases ordered by this Commission and other regulatory jurisdictions, the Company's financial condition continues to be critical.

The approval of the requested rates so as to allow the Company to restore its coverage of fixed charges and preferred dividends and to earn a reasonable return on equity capital is absolutely essential in order for the Company to continue to finance its operations and to provide adequate and dependable service to its customers'7-

South Carolina Public Service Commission Docket Nos. 18,361 and 18,387 CAROLINA POWER & LIGHT COMPANY TESTIMONY OF PAUL S. BRADSHAW 1 Q. Please state your name and business address.

2 A. Paul S. Bradshaw, 336 Fayetteville Street, Raleigh, North Carolina.

3 Q. What is your occupation?

4 A. Assistant'Treasurer in charge of the Budgets and Statistics Section 5 of the Treasury and Accounting Department of Carolina Power & Light 6 Company.

7 Q. Please describe your educational background and business experience.

8 A. I attended Southeastern University and graduated from the Accounting 9 School'of that University with a Master's Degree in Accounting.

10 Immediately prior to joining Carolina Power & Light Company in July, 11 1962, I worked for the Washington Gas Light Company, a natural gas 12 utility, in Washington, D. C. I .am a member of the Finance Section 13 of the Southeastern Electric Exchange and also a member of the 14 Budgeting Committee of the Edison Electr'ic Institute. I have completed 15 the Public Utility Executive course at the Georgia Institute of 16 Technology.

17 Q. What are your duties with Carolina Power & Light Company?

18 A. I have been responsible for the operation of the Budgets and Statistics 19 Section since its formation in 1972. I am responsible for the 20 Budget Unit, Statistical Unit and Financial Analysis. Prior to 21 formation of the Budgets and Statistics Section, I was Assistant 22 Controller in charge of General Accounting.

23 Q. Please examine this document, marked "Bradshaw Exhibit No. 1,"

24 consistingof twelvepages, and state whether or not it was prepared 25 under your supervision and direction.

1 A. Yes, it was. (Identify) 2 Q. Will you describe this exhib5.t?

3 A. This exhibit sets out, the balance sheet of the Company as of 4 December 31, 1975, and statements of income and retained earnings 5 of the Company for the twelve months which ended December 31, 1975. -'

It contains notes which are an integral part of the statements.

7 This exhibit 'is the same as Exhibit I filed with the Commission 8 in. the series of exhibits containing data for the test period 9, consisting of the calendar year 1975.

10 Q. Will you please examine this document, marked "Bradshaw Exhibit No. 2,"

and state whether or not it was prepared under your supervision and 12 direction7 13 A: Yes, it was. (Identify) 14 Q. Please describe this exhibit.

15 A. This exhibit sets forth the original cost of the electric utility 16 plant in service of our Company as shown on our books and records 17 at December 31, 1975. After deducting $ 18,507,102, representing 18 the accumulated provision for amortization of nuclear fuel, the 19 total amount of plant in service and nuclear fuel is $ 1,888,955,553.

20 The plant in service is subdivided into functional accounts. Of 21 course, the nuclear fuel is related only to the production function.

22 This exhibit is the same as Exhibit C in the exhibits filed with 23 the Commission.

24 Q. Will you please examine this document, marked "Bradshaw Exhibit No. 3,"

25 and state whether or not it was prepared under your supervision and 26 direction, and state what is shown on this exhibit2

I A. Bradshaw Exhibit No. 3," which is the same as Exhibit D filed for the test period 1975, was prepared under my supervision and direction and states the amounts of the accumulated provision for depreciation of plant in service as shown on the books at 31, 1975. The amounts have been adjusted to reflect'ecember depreciation for a full year on plant in service at that date.

7 The amounts are shown by functional accounts corresponding to 8 the functional accounts under plant in service on my Exhibit No. 2.

9 Q. Will you please state whether or not Bradshaw Exhibit No. 4 was 10 prepared by you or under your supervision?

ll A. Yes, it was.L (Identify) 12 Q. Will you please describe this exhibit?

13 A. This exhibit shows the Company's operating revenues and operating 14 expenses by major categories for the calendar year 1975.

15 Q. Have you made any accounting and proforma adjustments to the test 16 year?

17 A. Yes. The adjustments made to the test year are summarized in 18 Bradshaw Exhibit No. 5.

19 Q. Would you please explain these adjustments?

20 A. Yes. Adjustment No. 1 was necessary to correct insurance expense 21 for the test year. Insurance expense applicable to the Brunswick 22 No. 2 unit in November and December 1975 was inadvertently charged 23 to plant account and should have been charged to expense. This 24 adjustment charges expense in the amount of $ 109,024.

25 Adjustment No. 2 is necessary'to charge-off one-fifth of the 26 cost of abandoning the Craven County Plant site. The five-year

write-off was ordered by this Commission.

Il Adjustment No. 3 is to normalize the effect of hydro generation for the test year. The value of hydro generation in the test year was adjusted to the 45-year average hydro generation resulting in a charge to Expense of $ 1, 168, 558.

Adjustment No. 4 is to reflect wages for the test year based on the year-end level. This requires an increase in operating expenses of $ 4,560,087 and a related increase in payroll taxes of

$ 234,822.

10 Adjustment No. 5 is necessary to reflect in the test year the effect of a postage increase that was placed in effect December 28, 12 1975. The effect on operating expenses would be an increase of 13 $ 293,331.

Adjustment Nos. 6, 7 and 8 are to increase maintenance expense 15 for the test year to a more normal level. During 1975, because of 16 . low earnings and coverage, the Company was operating under a program 17 of reduced expenses in all areas possible. The expenses'hat were deferred or eliminated in 1975 must be resumed in the future.

During a normal operating year, additional maintenance expenses in 20 the amount of $ 5,217,000 would be required. The amount deferred in 21 each category was production - $ 507,000; transmission - $ 710,000; 22 and, distribution - $ 4,000,000.

23 Adjustment No. 9.was made to adjust depreciation expense to 24 the level of plant in service at year-end and also to compensate 25 for a change in depreciation rates. The change in depreciation 26 rates is the result of a study made by Ebasco Services, Incorporated,

and will be testified to in this case by Mr. Reilly.

Adjustment No. 10 is necessary to compensate for an increase in Social Security taxes. The PICA taxable wage base was increased from $ 14,100 to $ 15,300 thus necessitating an increase'o the test year tax expense of $ 57,508.

Adjustment No. 11 relates the property taxes to the year'end level of Plant in Service at the end of the test year. To adjust the property tax expense to the year-end level of Plant, in Service required an increase in pioperty tax expense of 10 $ 4,091,032.

Adjustment No. 12 is necessary to achieve comprehensive 12 interperiod allocation of income taxes. The adjustment in the amount of $ 15,614,000 to deferred taxes in the test year accomplishes full normalization of deferred taxes.

15 Q. Will you state whether or not the Company maintains bank balances 16 as a part of its commitment in connection with loans obtained 17 from banking institutions.

18 A. Yes.

19 Q. What was the amount of such bank balances supporting loan 20 commitments at December 31, 1975.

21 A. The amount of such balances then was $ 9,350,000. These funds 22 are not maintained to support normal bank accounting services 23 such'as checking and collection of funds deposited, but are 24 specifically required in connection with credit extension.

25 Q. Is the Company requesting any change in its treatment of deferred 26 fuel cost in this proceeding?

1 A. Yes, it is. The Company has been deferring the expensing of 2 increased fuel costs on its books until the month in which 3 related revenues are billed. However, beginning with the effective date of the new fuel clause proposed in this proceeding, we will no longer use deferral accounting for fuel expenses. At that time all fuel costs will be expensed on a current basis. When the new fuel clause goes into effect the books of the Company will contain two months'dditional fuel cost that must be collected from the customers.

10 This is fuel costs for the prior two months in excess of the base cost. This fuel has been used in serving the customers 12 and must. be paid for by the customers. Without collecting 13 revenues to cover these deferred fuel costs, the Company will be 14 unfairly penalized and earnings will be adversely affected.

15 Q. .How do you propose to collect this deferred fuel expense from the 16 customers?

17 A. We propose to collect the deferred fuel expense by a temporary 18 charge on the customer's bill for a period of approximately 19 12 months. The amount of the temporary charge will be determined 20 by the amount of deferred fuel expense attributed to South Carolina 21 retail sales at the time the new rates are placed in effect. This 22 amount could be collected in a shorter time period, but we 23 believe 12 months is a fair and reasonable time period. Assuming 24 the new rates are placed in effect September 1, 1976, the charge

will be .072 cents per 15lH based on the fuel cost deferred in July and August. This will be billed on Temporary Rider No. 40, which is attached as Bradshaw Exhibit No. 6. A copy of this Rider is also included in the Exhibit which presents the alternate rates that the Company is .requesting in this proceeding.

South Carolina Public Service Commission CAROLINA POWER & LIGHT COMPANY TESTIMONY OF JOHN J. REILLY 1 Q. Will you state your name and address?

2 A. My name is John J. Reilly, and my place of residence is Glen Cove, Long Island, a suburb of New York City.

4 Q. What is your occupation, Mr. Reilly?

5 A. I am a professional engineer employed by Ebasco Services Incorporated at 100 Church Street, New York City, and hold the position of Consulting Engineer.

8 Q. What kind of organization is Ebasco Services?

9 A. Ebasco has provided engineering, design, construction and 10 management consulting services to public utilities, other industries and governments for the past 70 years. It is one 12 of the foremost designers and constructors of power plants in 13 the world.

14 Q. Will you summarize briefly your education and professional 15 experience?

16 A., I am a graduate of Ohio University with a degree of Bachelor 17 of Science in Civil Engineering in the year 1932. I also 18 completed graduate courses in Power Plant Engineering at 19 Columbia University during 1939 and 1940. During the period 20 1933-1937, I worked for the City of New York as Structural 21 Design Engineer. I was employed by Ebasco Services Incorporated 22 as a Design Engineer in April .1937. Since 1937, except for a

two-year period of service in 'the Navy, I have been continuously employed by Ebasco. During the ma)or part of the 37-year period I have been engaged in engineering work closely related to the appraisal of industrial property. These appraisal studies were made generally for acquisition sale, financing, rate condemnation and tax purposes, or to satisfy the requirements of local, State and Federal regulatory agencies. During this 37-year period, I assisted with appraisal studies for some 200 industrial and government clients, more than half of which were public utility 10 clients. During this same period I either made or directed approximately 125 depreciation studies for some 55 public utility 12 clients. In connection with these appraisal or depreciation

.13 studies, I participated in conferences, or hearings, as a

'4 consultant, or expert witness, in proceedings before the following 15 regulatory agencies:

16 Florida, Idaho, Indiana, Kansas, Massachusetts, Nevada, 17 New Mexico, New York, North Carolina, Ohio, Pennsylvania, 18 Rhode Island, South Carolina, Virginia, Washington, 19 State Public Utilities Commission, 20 Federal Maritime Commission, 21 Federal Power Commission, 22 Department of Justice and 23 Internal Revenue Service.

24 I have also appeared as an expert valuation and depreciation 25 witness before Courts of law in the United States and Canada.

26 Q. I- show 'you a document consisting of seven pages entitled Depre-27 ciation Studies involving Statistical Methods Made for Public 28 Utility Clients and ask you if that is a list of public utility 29 clients for whom you have made depreciation studies?

1 A. Yes it is.

2 Q. Are you a Licensed Professional Engineer?

3 A. Yes, I am a registered Professional Engineer in the states of 4 Indiana, Louisiana, New York, Pennsylvania, Rhode Island, Virginia, Texas, and Washington. .I also hold a certificate of qualification issued by the National Bureau of Engineering Registration.

8 Q. Are you a member of any professional societies?

9 A. Yes, I am a member of the American Society of Appraisers and 10 the American Society of Civil Engineers and formerly a member 11 of the Depreciation Accounting Committee of the Edison Electric 12 Institute from 1949 to 1973.

13 Q. Was Ebasco employed by Carolina Power & Light Company to make a 14 depreciation study in preparation for this case?

15 A. Ebasco was given an assignment to make a depreciation'tudy of 16 the Company's electric plant in service at December 31, 1974.

17 Q. How long has Ebasco been making depreciation studies for CP&L?

18 A. Ebasco has been making depreciation studies periodically for the 19 Company since 1950, when it adopted straight-line depreciation 20 accounting to meet the requirements of the uniform system of 21 accounts of the North Carolina, South Carolina and Federal Power 22 Commissions. These depreciation studies were made by Ebasco 23 every five years since 1950. As a result of each study, Ebasco 24 recommended annual depreciation rates for all functional classifi-25 cations of property and the Company generally adopted our 26 recommendations for depreciation accounting purposes.

1 Q. Were these depreciation studies made by you or under your direction?

3 A. Yes.

4 Q. I hand you this exhibit entitled, "Carolina Power & Light Company Depreciation Study of Electric Plant in Service at December 31, 1974", and ask if it was prepared 'under your supervision and direction?

8 A. Yes, it was. (Identify as Reilly Exhibit No. 2.)

9 Q. Please explain this exhibit.

10 A. Reilly Exhibit No. 2 is the latest of the periodic depreciation studies which I have mentioned above. It contains the results 12 of our current investigation of average service lives, salvage and cost of removal for the various classes of property which 14 the Company owns and the theoretical depreciation reserve 15 requirement at December 31, 1974, based on the assumption that 16 these average service lives and net salvage had been used to 17 compute the annual depreciation expense .during the expired life 18 of the property as of that date. We propose to amortize the 19 difference between the theoretical depreciation reserve, so 20 computed, and the book reserve over the estimated remaining life 21 of each class of property at December 31, 1974. This procedure, 22 which has been recommended by the National Association of Rail-23 road and Utilities Commissioners, results in the inclusion of 24 $ 1,354,000 per annum as part of the annual depreciation expense.

The-annual depreciation rates which we 'recommend for the year 1975, as shown in Schedule l of Reilly Exhibit No. 2, contain the provision for this amortization.

4 Q. Mr. Reilly, what are the bases for the lives, curve types and 5 net salvage rates you have selected for the various plant 6 accounts?

7 A. Generally the average service lives, Iowa Curve types and net

,salvage selected for each account are based on my judgment after giving consideration to our analysis of available past 10 retirement experience as determined from CP&L property account-ll ing records; present and anticipated future system requirements 12 of CP&L; and industry-wide experience and trends relating to 13 future life expectancy of various classes of property.

14 Q. Mr. Reilly, can you be more specific by explaining to us the 15 approaches you used for each of the functional .classes of 16 property?

17 A. Yes, I can. First, we looked at the production plant function 18 and segregated it into two separate groups. One contained the 19 production plants comprising the fueled type of generation and 20 included nuclear, fossil fueled steam plants and gas turbine 21 units, while the other contained the Hydraulic Production, Plants.

22 The decision to approach steam, nuclear, and gas turbines 23 generation facilities as functional groups stems from the fact 24 that upon retirement of a generating unit, all associated

components are no longer useful. Modern plant structures are also of little, if any, use for other purposes. Massive out-lays of capital for large plants together with little retire-ment experience 'for comparable plant limit the use of actuarial studies. For the fueled generating plants, there was little Company experience with regard to past retirements and there occurred many new and important events since my last study which, in my opinion, would have a greater effect on my selection of lives of these production facilities than past-10 retirement experience considered alone. There were basically three events which can be classified in two categories:

12 (1) environmental and (2) fuel, that occurred since 1970 which 13 have had drastic economic effect on this functional category.

14 Mr. Reilly, will you please explain the events which occurred 15 in the environmental category to which you gave consideration?

16 A. Yes, I will. Prior to the late 1960's, there was little acknow-17 ledgement on the part of the government or by the public as to 18 the pollution of the environment by our industrialization. Some 19 electric utilities were keenly aware of it and included precipi-20 tators in all their coal-fired power plants. Other electric 21 utilities, primarily those in larger urban areas, installed 22 precipitators only in their newer larger plants, while some 23 electric companies installed none at all. 'he action which 24 brought the problem of pollution into focus and to the attention

of the public and industry, under the pressure of concerned groups, began in 1970 with the enactment of the "Clean Air Act of 1970", which required that the Administrator of the Environmental Protection Agency (EPA) promulgate national

'5 primary and secondary ambient e

air quality standards. This act further required each state, within nine months after lf publication, to submit a plan for the implementation, main-tenance, and enforcement of the standards:

"...as expeditiously as practicable but...in no case 10 later than three years from the approval of such plant" for the primary standards. It also required 12 the implementation of the secondary standards in 13 "...a reasonable time."

14 Two years later, the "Federal Water Pollution Control 15 Act of 1972" was passed. This act, aimed at eliminating 16 polluting discharges into navigable waters by 1985, requires 17 that industries must have the most practicable cleanup equipment installed by 1977, and absolutely the best techno-19 logical equipment working by 1983 regardless of cost.

20 Chemical limitations will become effective in 1977, with 21 additional controls in 1983, and thermal limitations are to 22 become effective July 1, 1981, with possible deferral of 23 compliance to July 1, 1983, if a system's reliability would 24 be seriously affected.

1 Q. Mr. Reilly, turning to the fuel category, will you please explain 2 the events that occurred and which you considered in arriving at' your decision?

4 A. Yes, I will. Subsequent to the promulgation of the acts I just 5 cited, the fuel oil crisis of 1973, which continues unabated, has 6 further aggrevated the conditions and affected the economics of electric energy generation. The fuel oil situation in 1973 and 1974 has further aggrevated and complicated the conditions under which electric utilities operate. Fuel costs have risen and 10 probably will continue to rise to new and higher levels. Even competitive fuels, coal and nuclear, will rise as the demands for 12 these increase with the trend away from oil. The scarcity of 13 natural gas will probably limit its use in the generation of 14 electricity. Most recently, the stated goal for this nation to 15 become energy independent will result in the search for oil and gas 16 in'emote and inaccessible areas, e.g., the Alaskan slope, from 17 which transportation costs will be a significant factor. The search 18 and development costs for other exotic energy conversion methods and attendant facility costs, such as coal gasification, in this

/

20 high capital construction and financing era do not presage a quick k

21 and inexpensive solution.

22 Q. What has been the effect of these events as they relate to the

23. determination of average service lives and annual depreciation 24 rates for fueled production plant?

1 A. As a result of these events, the =entire fossil fuel generation function is in a state of flux due to the requirements for air

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quality control, cooling water pollution control and the effects of the fuel crisis. Any monies expended on old plants to meet environmental protection requirements must be recovered over the remaining life of the facility. (Fuel costs have risen and will continue to rise, forcing difficult decisions, as to the continued use of an old, less efficient plant.) The economics of increasing fuel costs tied to additional substantial 10 outlays of capital for air quality and/or water pollution control may well limit the life of old plants. We, therefore, deem it 12 advisable to lower the service life of existing steam generating 13 facilities notonly in order to recoup the capital spent on 14 environmental protection equipment but also due to a distinct 15 possibility of early retirement for economic reasons.

3 Therefore, 16 we have recommended the lives and depreciation rates shown in 17 Schedule II of my Exhibit No. 2 for steam, nuclear, and other 18 production plant accounts.

19 Further, if the expected amount of capital required for SO 20 removal in the future is actually spent to make older plants meet 21 environmental requirements, then the annual depreciation rate as 22 recommended in this report could be inadequate.

23 g. Mr. Reilly, will you summarize the effects of your consideration 24 of these events?

1 A. Yes. For Steam Production Plants, all of the aforementioned were taken under consideration in our recommendation to increase the normal depreciation rate for those steam gene-rating facilities we have classified as "Other Steam Production Plant" from the current 2.468 percent to 2.947 percent. New steam plants of large size will be subject to even more stringent air and water control equipment than older plants. While the expected life of production plant equipment itself may not be changed significantly, the 10 associated environmental equipment may require replacement 1 or 2 times over the plant's lifetime. Little historical 12 knowledge is available for plants operating at high temperatures.

13 It would be appropriate to expect a higher level of retirement 14 and replacement of plant components subject to the higher 15 temperatures and steam pressures to result. It is our opinion 16 that new steam production plants represented by Roxboro Nos. 1, 17 2 and 3, Asheville No. 2, and Sutton No. 3, plus any new plants 18 coming into service should have a normal depreciation rate of 19 3.452 percent, which is 0.595 percent higher than the 2.857 percent 20 recommended in 1969. The rates for both old and newer steam production include an allowance of 5 percent net cost of removal 22 (negative net salvage for Account 311 Structures and Improvements 23 and Account 312 Boiler Plant Equipment. The Iowa Type Curve 24 applicable to the steam plants was selected by judgment.

With regard to Nuclear Production Plant, at the time of our previous study the Company did not have any Nuclear Production Plants in service. No statistical data are avail-able to make a historical analysis to determine the average life applicable to this relatively new type of plant, either on a Company basis or on an industry-wide basis. Therefore, by judgment we have selected a depreciation rate of 4.225 percent. This is based on a 25-year average service life for all components, together with a negative 10 percent salvage 10 factor for Accounts 321 - Structures and Improvements, and 322 Reactor Plant Equipment.

12 With regard to Other Production Plant, the Company's 13 historical data are insufficient to apply statistical techni-ques to determine the average life of the gas turbines and 15 related equipment included in Other Production Plant. The 16 Company is currently using a 30-year average life. Due to the 17 critical fuel supply for oil-or gas-fired turbine peaking 18 plants, it is our opinion that the shortening to a 25-year

'9 average life is reasonable at this time. Since we have 20 estimated zero percent net salvage, the recommended annual 21 depreciation rate is 4.000 percent.

22 Turning to the balance of the production function, Hydraulic 23 Production, the depreciation rates I recommended in my Exhibit 24 No. 2 are based on the composite of the average lives assigned

to each of the major components comprising the account. The annual depreciation rate for each primary account for each plant is based on the composite of the average lives assigned to each of the major components comprising the account as of December 31, 1948, in the Ebasco study as of that date.

Certain changes were made to the original average lives as assigned in 1948. The lives shown of the detailed sheets reflect the changes and support the annual rates used.

The rates for, the Walters Plant were originally used in 10 our previous report entitled, "Carolina Power & Light Company-Walters Project No. 432 - Actual Legitimate Original Cost and 12 Accrued Depreciation (Recalculated with 150 year Ceiling Life) 13 Summary of Reserve Balances Years 1930 to 1956 Inclusive",

14 which was submitted and accepted by the Federal Power Commission.

15 The Blewett Falls and Tillery rates were used in our report 16 "Carolina Power & Light Company - Blewett Falls and Tillery 17 Hydroelectric Developments Projects No. 2206 Summary of 18 Recommended Depreciation Rates and Reserve Balances'Years 1912 19 to May 1, 1950, Inclusive (Dated) November 1961 Revised 20 January, 1962. These rates were accepted by the Federal Power 21 Commission. The determination of rates for the Marshall hydro-22 electric plant Project No. 2380 follows the same method that 23 was applied to the other licensed projects.

12'-

Q. Mr. Reilly, now that you have explained the basis for your determination of lives for production function, will you 3 please continue with your explanation of how you selected 4 the lives and depreciation rates for the other functional' groups?

6 A. Yes, l will. As I indicated in Exhibit No. 2, in general, the investigation of the service lives and mortality characteristics of the property in each account, other than production, plant, involved the following steps:

10 1) An analysis of available past retirement experience I

from Company's acco'unting records, and 2) the modification 12 of the results of the analysis of such past retirement 13 experience to reflect judgment as to (a) present and antici-14 pated future system requirements and (b) industry-wide 15 experience and trends relating to future life expectancy of 16 various classes of utility property. The Actuarial Method 17 of life analysis using dollar units was employed in compiling 18 mortality statistics. Data through December 31, 1973, was 19 analyzed.

20 The periods of years selected to provide experience data 21 for the life studies involving the methods l will discuss 22 shortly, was limited by the following considerations:

23 1) Primary accounting data must be on a consistent basis

2) Experience used must be fairly indicative of what 25 might reasonably be expected in the future 26 3) Availability of useful data

1 Q. Mr. Reilly, earlier you mentioned "curve types" and "net 2 salvage". Can you explain these terms and how you arrived 3 at these factors?

4 A. Yes. The actuarial method used to determine average service 5 lives for the various types of property also yields informa-tion as to the dispersion of retirements about that average age. In our study, we matched these dispersions with those, of the well known and frequently 'used Iowa Curves.

Net Salvage is the difference between the cost of removal 10 and salvage value received fram property retired. The net salvage percentages used in this report are expressed as a 12 percent of original cost.

13 Q. Mr., Reilly, at this time will you explain the actuarial studies 14 you made?

15 A. Yes. The Actuarial Method of life analysis using dollar units 16 was employed in compiling mortality statistics for all accounts 17 other than the production plant. Data through December 31, 18 1973 was analyzed. This method of analyzing past experience 19 represents the application to industrial property of statistical 20 procedures developed in the life insurance field for investigating 21 human mortality. It is distinguished from other methods of life 22 estimation by the requirement that it is necessary to know the 23 age of the property at the time of its retirement and .the ages'f 24 survivors, or plant remaining in service; that is, the installation date must be known for each particular retirement

and for each particular survivor. The application of this method to the Company's experience involved the statistical procedure known as the "annual rate method" of analysis.

This procedure relates the survivors of a given age in an account to the survivors of the previous age-year, thus yielding a sequence of annual survival probabilities* from which a survivorship characteristic can be constructed. Similarly the ratio of retirements of each age.-year to the survivors of the previous age-year may be used to get a series of mortality 10 probabilities which may be converted into a survivorship characteristic. The mathematical combination of these two factors results in a series of relationships which, if plotted 13 on graph paper, form what is known as a survivor,'r mortality 14 curve. The length of this curve depends primarily upon the 15 years of experience available; so that, if the experience band 16 of years is short in relation to the average life of the property, 17 an incomplete or stub survivor curve results. There are a number 18 . of acceptable methods of smoothing and extending this stub 19 survivor curve in order to compute the area under it from which.

20 the average life is determined. The well-known Iowa Type Curve 21 Method was used in this study. In 1935, the Iowa Engineering 22 Experiment Station of Iowa State College published Bulletin 125 23~ entitled, "Statistical Analyses of Industrial Property Retire-24 ments" by Robley Winfrey. This bulletin describes the

development of 18 type mortality curves and their applicability to 'industrial property having .a wide range of mortality characteristics. Since their publication in 1935, these .type curves have been frequently used by public utility operating companies for depreciation accounting, tax, rate and other purposes. They have also found general acceptance with the Securities and Exchange Commission', the Federal Power Commission, the Bureau of Internal Revenue and many state public utility '

commissions.

10 Q. Please continue with your explanation of your actuarial studies ll of life analysis.

12 A. In the mortality study of the Company's property, instead of mathematically smoothing and pro)ecting the stub survivor curve 14 to determine the average life of the group, it was assumed that 15 the stub curve would have the same mortality characteristics as 16 the type curve selected. The selection of the appropriate type 17 curve and average life was accomplished by plotting the stub 18 curve on transparent graph paper and superimposing it on Iowa 19 curves of the various types and average, lives drawn to the same 20 scale, and then determining by judgment which Iowa curve type 21 best suited the stub. In some accounts when this method was 22 used, average lives different from those indicated by the stub 23 curve were selected on the basis of judgment. Such judgment 24 took into a consideration factors which indicated that the 25 Company's past experience was not a reasonable criterion of 26 future life expectancy for the facilities now in service in those 27 par t'icular accounts.

1 Q. What was the basis of your determination of net salvage rates?

2 A. The net salvage percentages used in this report are expressed 3 as a percent of original cost and were based primarily on judgments However, in determining this judgment, considerable weightwas given to the results of an analysis of the Company's experience with respect to salvage and removal costs for the period of years 1969-1973, inclusive. The net salvage ratios shown on Column V in the summary in Schedule IX of this exhibit may be explained as follows:

10 1. Where the ratio is shown as unity (1.00), it was assumed that the net salvage in that particular

'2 account would be zero.

13 2. Where the ratio was less than unity, it was assumed 14 that the salvage exceeded the demolition costs.

For example, where the net salvage was 20 percent, 16 the net salvage ratio was expressed as .80.

17 Where the ratio was greater than unity, I'.

it was,'ssumed 18 that the demolition costs exceeded the 19 salvage. For example, where the net salvage was 20 minus 5 percent, the net salvage ratio was expressed 21 as 1.05.

22 These net salvage ratios were used in computing the annual 23 depreciation rate for each primary account in order that the 24 ,'ate could be applied to the gross balance in the account

when calculating the annual depreciation accrual. For example, if the average life for an account were 50 years, the annual depreciation rate with zero net salvage would be 2.0 percent.

However; if the >et salvage ratio were .90, the annual depre-ciation rate adjusted for net salvage would be the product of' the two, of 1.800 percent.

I 7 Q. Where in your Exhibit No. 2're the results of your mortality 8 study summarized?

9 A. Schedule II summarizes the results of my mortality study. In 10 Column IV under the heading Average Life and Iowa type curve selected, the letters .R, S, and L, together with the numerical 12 suffix, which accompanies them, represent the Iowa, type curve selected for each account. The number prefixed to the letter 14 is the average life in years, which together with the net 15 salvage ratio shown in Column V determines the annual depreci-16 ation rate shown in Column VI of the Summary. Column VII 17 represents the application of the rate in Column VI to the 18 Original Cost at December 31, 1974, for each primary plant account, is used to determine the annual depreciation rate 20 applicable to each of the functional groups.

21 Q. Mr. Reilly, will you please describe Schedule III of your Exhibit 22 No. 2?

23 A. Yes. Schedule III is a comparison of the estimated Reserve 24 Requirement at December 31, 1974, based on the average service

1 'ives, curve types and net salvage selected for each primary 2 plant account, with the book Reserve for Depreciation. The 3 comparison indicates a difference of $ 34,536,000.

4 Q. Mr. Reilly, can you explain the reasons for this difference?

5 A. Yes. The largest part of, the difference between the calcu-lated reserve and the book reserve at December 31, 1974, is

'due to the change in average life and net salvage percent selected for Steam Production Plant. This change has been t

caused primarily by the environmental requirements imposed on 10 this type of plant as well as the fuel situation, both of which I discussed in detail and occurred since our 1969 depre-12 ciation study. Schedule III in this Section shows that of 'the 13 $ 34,536,000 difference between the calculated reserve and the book reserve, $ 23,005,000 is in the Steam Production Plant.

15 The difference in Transmission Plant and Distribution 16 Plant is caused mostly by the inclusion of 'Rights of Way 17 accounts in depreciable plant for depreciation accounting

-18 purposes only after 1968, when the Internal Revenue Service 19 allowed the recovery of such costs through a depreciation 20 deduction for Federal Income Tax purposes. Prior to that time, 21 the Company treated these accounts as nondepreciable 'and no 22 depreciation accrual was made to the book reserve for these 23 accounts. Changes in the selection of average life, curve

type and net salvage percentages based on experience since the 1969 study and judgment have created the relatively minor differences between the calculated reserve and the book reserve in the other functional plants. Since our 1969 study, the difference between the calculated reserve and the book reserve r

has increased from about 1 percent of depreciable plant to about 2.5 percent.

As discussed on page 187 of Reilly Exhibit No. 2, I feel that the proper treatment of this difference at this time is 10 to adjust the normal annual recommended depreciation rates to include an allowance that will adjust for this difference over 12 the average remaining life of each functional plant in which a 13 difference exists. The computation on Schedule I derives the 14 composite recommended depreciation rates for 1975'or each 15 functional plant, including this adjustment. The calculations on Schedule II in this exhibit determine the actual amount of 17 normal depreciation based on plant in service at December 31, 18 1974. By "normal" we refer to that amount of depreciation

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19 using rates that are based on the average service life and net 20 salvage factor only. To this amount, I added the amount 21 necessary to amortize the difference between the 'calculated 22 reserve -and the book reserve per Schedule .III to determine the 23 total depreciation from which the recommended rates have been

'4 derived in Schedule I for the year 1975.

1 Q. Mr. Reilly, can you summarize for us the effect of CP&L adopting 2 your recommended depreciation rates?

3 A. The adoption of my recommended depreciation rates, together with 4 . the amortization of the difference between the theoretical depreciation reserve and the book reserve as of December 31, 1974, will allow the Company to recover its investment in Electric Plant in Service in a rational and uniform manner over the remain-ing life in a plant in service estimated by me as of December 31, 1974.

A. My primary responsibility was the assignment and allocation

)

of rate base components, revenues, expenses, and capital structure to the South Carolina retail operations, which are 4 subject to the jurisdiction of this Commission. The results of these assignments and allocations are shown on the various test period exhibits filed in this proceeding. The original Applications were based on a 1974 test period. Subsequent to the filing of the original exhibits, the test period has been updated to the year 1975. The revised exhibi.ts for the 1975 10 test period are presented in the testimony of Mr. Bradshaw and Mr. Davis, to whom I furnished the results of the allocation of the system totals to determine the amounts for the South 13 Carolina retail operations.

14 I was also responsible for preparation of the 1974 Retail 15 Operations Cost Allocation Study based on the present rates annualized. This study provides an indication of the relative 17 rates of return earned by the various retail customer rate 18 classes. My testimony 'will include a discussion of the proce-19 dures used to accomplish the study and the results obtained 20 for the retail rate classes.

21 Q. Were the allocations to obtain the South Carolina retail 22 jurisdictional operating results accomplished under your super-23 vision and direction?

24 A. Yes, they were, and they consisted of methods previously 25 presented to this. Commission. In summary, I would state that

the power supply allocation was accomplished on the basis of coincident peak demand. This allocation method states the power supply responsibility for production and transmission cost on the .basis of the demand at the time of our annual summer peak demand. We believe that this method properly reflects the cost of providing service and relates our revenue levels to the peak load of our system. We have used this peak load cost formula in our last two rate filings prior to this case and recommend its approval again in this 10 proceeding. The allocation of the remaining cost items was accomplished in the same manner as in our previous rate filings.

12 Q. Would you please explain the jurisdictional allocation study in 13 more detail?

14 A. The results of system operations including adjustments were 15 apportioned to retail service in South Carolina by a series of 16 steps which began with a study to identify those items related 17 solely to service to specific classes of customers. Those 18 items were then assigned directly to the related classes. Those 19 matters which arose from joint-use and thus could not be assigned 20 directly to specific classes were allocated by the application of 21 standard analytical methods. All items were grouped according to 22 the functions to which they relate production, transmission, 23 distribution, administrative and general, sales and customer

accounting. Allocable items were also classified as to whether they'were demand-related, energy-related, or customer-related.

Allocations of demand-related items were made using coincident peak demand factors. Energy-related items were allocated by using kilowatt-hour ratio factors.

6 Q. Will you please explain briefly how each major revenue, expense, 7 and rate base item was allocated, beginning with operating 8 revenues?

9 A. Operating revenues from sales at retail in South Carolina are 10 readily identified and therefore have been assigned directly to the South Carolina retail class. Other operating revenues consisting of a number of miscellaneous items were either 13 assigned directly or apportioned by appropriate analysis and factors.

Q. Please describe the allocation of the operation and maintenance 16 expenses.

17 A. Before the operation and maintenance expense items could be 18 functionalized into categories for allocation, it was necessary 19 to prorate the supervision and engineering expenses for each 20 expense account. An analysis provided the amount of the payroll 21 charges included in the total expense items. The respective 22 supervision and engineering expenses were then apportioned to 23 the various expense accounts based on this labor component. By 24 this means the primary accounts were restated to include a pro-25 rated portion of the supervision and engineering expense.

The expenses as thus restated were then classified as either energy-related, demand related, or customer-related.

The production expense items classified as energy-related are fuel, the energy portion of purchased power, boiler plant maintenance, electric plant maintenance, reactor plant maintenance, and nuclear electric plant maintenance.. The remaining power production expenses were classified as demand-related.

The transmission expense was assigned b'etween power supply 10 production and power supply transmission based on the ratio of the plant in service. The distribution expense was divided 12 functionally between substations, overhead lines, underground 13 lines, meters, and other distribution expense. These function-14 alized expenses were assigned to each state and then allocated 15 to,the jurisdictional classes within the states on the basis of 16 the respective distribution plant accounts.

The customer accounting expense was assigned based on a 18 specific analysis which separated the cost involved between 19 wholesale and retail service in each state. A portion of the 20 expense of the customer services personnel who are directly 21 involved in wholesale sales was assigned to the wholesale 22 operation in each state. The remaining sales expense was 23 assigned to the retail class.

Regulatory expense has been analyzed and assigned to the respective jurisdictions. The remaining administrative and general expenses were allocated to the customer classes principally by the use of labor factors. Certain items such as property insurance and maintenance. of general plant were allocated on plant ratios.

The operation and maintenance expense adjustments were allocated on the same basis as the items to which the adjust-ments related.

'0 Q. Would you please explain the allocation of the depreciation expense?

12 A. Depreciation expense was assigned in accordance with the assign-13 ment and allocation of the functional plant to which the depre-14 ciation related. The adjustments to the depreciation expense 15 were similarly functionalized and allocated on the basis of the 16 respective functional plant account.

17 Q. Please describe the allocation of the remaining operating 18 expense items.

19 A. Taxes other than income were assigned for allocation as related 20 to labor, property, KWH sales, or revenue and were then allocated 21 by the respective allocation factors. Unemployment taxes were 22 considered labor-related, property taxes were considered related 23 to plant investment, the South Carolina electric power generation 24 tax was classified as KWH-related, and revenue taxes such as the 25 North Carolina gross receipts tax were treated as related to 26 revenue.

State income taxes were assigned specifically to the respective states and then allocated to classes on the basis of the ratios of income before taxes. Federal income taxes were calculated for states and for classes using allocated taxable income. The provision for deferred income taxes and the investment tax credit were functionalized into production, transmission, distribution and general categories, and then 8 allocated on the basis of the respective plant allocations.

9 Q. Will you please explain the allocation steps used to determine 10 the portion of the electric plant used in providing service to ll South Carolina retail operations?

12 A. The allocation of electric plant in service consisted of two 13 basic steps. The first step was to specifically assign all items 14 of cost for which sufficient information allowed a specific as separation between classes. This step involved separating the 16 cost associated exclusively with the wholesale operation and also 17 joint costs which were allocated on a specific basis. The second 18 step was to allocate the costs where the joint use was so thorough 19 that a specific analysis was not practical. These costs were 20 assigned for allocation to the classes of service and the alloca-21 tions were accomplished by the use of allocation factors developed 22 for the respective classes.

23 Allocations of the power supply production and .power supply 24 transmission facilities were accomplished using the coincident

peak demand allocation factors. All allocations of facilities below the level of power supply transmission were accomplished by use of NCP demand allocation factors. The NCP factors for each of these specific allocations were developed by an analysis of the demands imposed on the facilities being allocated.

The production plant in service was allocated between classes of service by KW demand allocation factors developed from system load data. These KW demand allocation factors were based on data adjusted to the production level. No production 10 plant account dollars were specifically assigned to classes of service. The transmission plant in service was allocated 12 between the classes by KW demand allocation factors developed 13 from system load data. No transmission plant account dollars 14 were specifically assigned. It was necessary, however, to 15 separate the transmission plant into two levels for allocation 16 by KW demand factors. Since the function of the step-up trans-formers at the various generating plants is considered to be 18 production, these facilities were allocated using the production 19 KW demand allocation factors. All other transmission facilities 20 were allocated using transmission KW demand allocation factors.

21 The investment in distribution facilities was assigned 22 between the states on a geographical basis as shown directly on 23 the books of the Company and between the wholesale and retail 24 classes on the basis of specific analysis. General plant was

first placed in the functional categories in its relationship of use with the production, transmission, or distribution facilities. The amounts thus functionalized were then assigned on the same b'asis as the respective functional plant accounts. The item for intangible plant was assigned on the basis of the other electric plant.

The depreciation reserve distributed on the books to the functional plant from which it results was assigned in accordance with the plant assignment.

10 Q. Would you please now describe the allocation of the other rate base items?

12 A. Net nuclear fuel, which consists of nuclear fuel assemblies in 13 the reactor, nuclear fuel in process, and spent nuclear fuel, 14 was allocated by the use of KWH energy factors. The fuel portion 15 of materials and supplies was allocated by energy factors. Other.

materials and supplies were analyzed as to their type and were 17 allocated according to the assignment of related plant. The bank 18 balance portion of the cash working capital allowance was assigned 19 in accordance with plant investment. Prepayments were assigned by 20 specific analysis or by allocations based on gross plant. The 21 cash allowance was assigned in the same proportion as the operation 22 and maintenance expenses. Deducted from cash working capital were 23 average tax accruals and customer deposits. The tax accrual offset 24 was allocated in accordance with plant investment. Customer 25 deposits were directly assigned to the proper jurisdiction.

1 g. Where are the results of applying these allocation procedures 2 to the 1975 test period shown in this proceeding?

3 A. The results of my 5urisdictional allocation study are shown in Davis Exhibit No. 1. I provided to Mr. Davis the South 5 Carolina retail allocated portion of the cost of service that 6 he is presenting in his testimony.

7 g. Will you please now turn to the next part of your testimony relating to the procedures and results of the Retail Opera-tions Cost Allocation Study for the 1974 test period. Please 10 summarize what is meant by a retail operations cost allocation 11 study.

12 A. A retail operations cost study allocates system cost and devel-13 ops a rate of return for each of the retail classes. The study 14 allocates the revenues, expenses, and rate base between the 15 various retail classes. The rate of return is derived by 16 measuring net operating income as a percent of average net 17 original cost rate base.

18 Horne Exhibit No. 1 describes the procedures that are used 19 in our retail cost allocation studies. The methods and )udgment 20 used in our retail cost allocation studies are extensions of the methods used in the preparation of jurisdictional allocation 22 studies. While advice for portions of the study is obtained from 23 consultants, the studies are accomplished by Company personnel.

Recognized and accepted allocation procedures are used through-out the studies. For the major components, these procedures conform to those used in the recent rate hearings before the regulatory commissions in the two states which the Company serves.

6 Q. How were the cost data and customer information obtained to 7 apply these allocation procedures in the retail studies?

A. The basic cost data for the study were taken from the books and records of the Company. Adjustments have been made to include 10 the effect of known changes during the year. However, these adjustments do not include all the items that would be necessary 12 if the results of this type of study were to be used to determine the rate levels of the Company.

14 Fundamental to appraising the results of this type of allo-1S cation study is a recognition that the use of an average 16 original cost rate base without all of the adjustments normally 17 included in a ratemaking proceeding is appropriate in a study of 3.8 the relationship of rates to each other but not in considering 19 the adequacy of the overall rate of return.

20 Q. Was the document marked Horne Exhibit No. 2 prepared by you or 21 under your supervision and direction?

22 A. Yes, it was. (Identify) 23 Q. What is shown in this Exhibit?

24 A. This Exhibit presents the results of our Retail Operations Cost 25 Allocation Study for the year 1974 on the basis of the present 26 rates annualized.

1 Q. Does this Study for 1974 provide the information which is 2 necessary in the establishment of the rates for the various retail classes of service?

4 A. No. This Study only provides an indication as to the relative rates of return that are being earned by the various rate classes. It attempts to analyze and consider cost factors in providing service to the various customer classes. This study, however, does not consider all of the factors which are essential in setting rate levels and the design of the 10 resulting rate schedules.

The end results of the accounting and the engineering 12 procedures involved in cost allocation studies do not establish 13 value of service or even levels of reasonable rates. The 14 results simply reflect the total cost assigned to the rate 15 classes by following basic principles with logical and 16 supportable procedures starting from the premise of allocation 17 joint costs. The resulting rates of return can serve only as 18 a guide, under the assumptions of the study, to the relative 19 earnings of the various rate classes. Proper rates can be 20 established only after consideration of all the factors rele-21 vant to their justness and reasonableness. A retail class cost 22 allocation study is one of the aids in that task.

South Carolina Public Service Commission CAROLINA POWER & LIGHT COMPANY TESTIMONY OF JAMES M. DAVIS, JR.

1 Q. Please state your name and address.

2 A. James M. Davis, Jr., Raleigh, North Carolina.

3 Q. What is your position with Carolina Power & Light Company?

4 A. I am Assistant Director of Rates and Regulation.

5 Q. Will you briefly describe your educational and professional 6 background.

7 A. I am a graduate of North Carolina State University, from which

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I recei'ved a Bachelor of Science Degree in Mechanical Engineer-ing. After three years'ervice as an officer in the .U. S.

10 Air Force, I was employed by Pratt and Whitney Aircraft as a test engineer in the Experimental Engineering Department. In 1965, I went to work with Carolina Power & Light Company as an 13 engineer in the Special Services Section. I joined the Rates 14 and Regulation Department in February, 1968, and in July, 1970, 15 I was named to my present position.

16 My education in the ratemaking area has consisted of parti-17 cipation in the development of the load survey, cost analysis, 18 rate evaluation, and rate design programs of the Company. This 19 work has included the studies that were necessary in the prepara-20 tion of the filings and case materials for retail and wholesale rate increase requests, including our Company's prior requests to 22 this Commission. I have attended a training program conducted by

Ebasco Services, public utility consultants, and I have worked with a number of rate consultants in the preparation of rate case material; I have attended meetings of the Rate Research Committee of the Edison Electric Institute. I am a registered 5 Professional Engineer in the State of North Carolina.

6 Q. Have you testified before a regulatory authority prior to this 7 case?

8 A. Yes, I have testified before this Commission in prior rate 9 proceedings and before the North Carolina Utilities Commission 10 and the Federal Power Commission.

11 Q. Please summarize your duties with Carolina Power & Light 12 Company.

13 A. The Department of which I am assistant director is responsible 14 for the development, issuance, and interpretation of the rates and service practices of the Company. I am responsible to the 16 Uice President and Director of Rates and Regulation for the 17 direction and supervision of the studies underlying the theoretical 18 and practical aspects of our rate structure; the preparation of 19 rates and revenue comparisons; the direction and supervision of 20 cost allocation studies; and the development of financial and cost 21 studies for rate case presentation. I supervised the rate of return 22 studies underlying the exhibits which have been filed in this 23 proceeding, and supervised the preparation of the proposed rates 24 and rate schedules.

25 Q. Mill you please explain the scope of testimony you .intend to offer 26 here?

1 A. I will present the proposed rates, including .a fuel adjustment 2 clause for the recovery of current fuel costs, for which the 3 Company is requesting approval of this proceeding. I will also 4 present the actual operating results of the Company .during the test period consisting of the calendar year 1975, with appropriate adjustments. This material will be presented on both a system-wide basis and, as indicated in the testimony of Mr. Horne, as allocated and apportioned to the operations which are 'subject to the jurisdiction of this Commission. My 10 testimony will show the monetary effect that the proposed rates ll would have had on the Company's operations, as adjusted, had the 12 changes been in effect during the test period 1975.

13 Q. Where have you shown the 1975 test period operating results with 14 the present rates in effect?

15 A. ~

Davis Exhibit No. 1 sets forth the operating experience for the 16 historical test period in this proceeding. This Exhibit is in 17 the same format as Exhibit G filed with our Application and has 18 been updated to reflect the year 1975 results. Column 7 sets 19 forth the allocated South Carolina retail operations. The proce-20 dures used to obtain the allocations were described in the 21 testimony of Mr. Horne.

22 This Exhibit shows the actual 1975 test period operations

'

23 adjusted to properly reflect for the purpose of jurisdictional 24 ratemaking those changing conditions which were not fully reflected in the actual results of the test period. Included

therein, are those proforma adjustments explained in the testimony of Mr. Paul Bradshaw. In addition, I have included certain adjustments which were calculated under my direction and supervision. These adjustments include the annualization for the effect of previously allowed rate 6 increases and the normalization and annualization of the

'7 addition of the Brunswick No. 2 generating unit.

8 g. Will you please explain the adjustments which you have 9 included; starting first w'ith the adjustment for prior rate 10 increases?

11 A. During the test period 1975, the Company received a retail 12 rate increase which was not fully reflected in the test 13 year revenues. It was necessary to compute the annual effect 14 'of this approved increase and add to the test year revenues 15 the additional revenues that would have been produced had 16 the approved increases been in effect throughout. the test 17 period. These adjustments restate the test year revenues to 18 reflect fully the effect of the prior rate increases which 19 occurred during the test period.

20 The second adjustment which I have included adjusts revenues, 21 expenses, and rate base to reflect the full annualization of the 22 addition of the Brunswick No. 2 nuclear generating unit. This 23 adjustment is essential to state the operating results 'of the 24 Company on the basis of a full year's operation of this new

generating resource. The adjustment includes many aspects to fully reflect the effect on our operating results from the addition of Brunswick No. 2. Each respective ad)ustment to revenues, expenses, and rate base was computed on the basis of the Brunswick No. 2 unit operating at a 72% capacity factor during the test period. This availability was selected because it reflects a full year's operation, including a refuel-ing cycle. We selected a 72% capacity factor on the assumption that the unit would be available on a basis equivalent to ful'1 10 power operation approximately 85% of the hours during the year, except'for a six-week outage for necessary maintenance and 12 refueling. This reflects an optimistic estimate of the avail-

"13 ability of this new unit and reflects a'full year's operation at 14 a substantial availability and load factor.

15 In order to compute the effects of the availability of 16 Brunswick No. 2 for the entire test period, it was necessary to 17 develop a power estimate which would restate the generation from 18 system resources to include the addition of this large nuclear 19 unit. Purchases and interchange transactions were also 20 analyzed to determine if purchases could have been reduced to an 21 economic advantage if the nuclear unit.Sad been available. When 22 this analysis was completed, the result stated the adjusted 23 generation from each of our existing units. This reduced'genera-24 tion was then analyzed to determine the fuel requirements that

would have existed with the reduced generation. Our fossil fuel purchases during the year 1975 were reviewed to determine the effect of the fossil generation which would have been replaced by the nuclear unit. In order to evaluate the fuel purchases, we eliminated the highest price spot purchases that were made in each month at each of the plant locations based on the reduced generation for that respective plant. We did not reduce contract purchases at any of our plant locations.

The reduced fuel purchases were then processed through our 10 fuel inventories to determine adjusted unit fuel prices. The adjusted fuel prices were then used as a basis to calculate 12 fossil fuel adjustment factors that would have resulted from 13 the adjusted fuel purchases and consumption. This calculation 14 was necessary to reduce the revenues that would have been by the fuel adjustment factor. 'roduced 16 The completion of these detailed calculations to fully 17 annualize the operation of the Brunswick No. 2 nuclear unit 18 resulted in the following adjustments. South Carolina retail 19 revenues were reduced by $ 5.0 million. The test year fuel 20 expense was reduced by a net of $ 4.3 million. Purchased power 21 expense was reduced by $ 1.0 million. Other 0&M expenses were 22 increased by $ 711,000. Depreciation expenses, property taxes, 23 fuel deferral, and working capital were also adjusted to con-24 form to the related adjustment items. The combined effect of

these adjustments was to state the test year on the basis of a full annualization and normalization for the addition of Brunswick No. 2 generating unit. The adjustments to fuel 4 expense and purchased power have also been included in the base cost for the proposed fuel adjustment formula in Davis Exhibit No. 3.

7 Q. Mill you please describe the rates proposed by the Company in 8 this proceeding?

9 A. The Company has filed two rate increase applications in this 'A 10 proceeding. On July 31, 1975, an application was filed for authority to adjust the rates for residential service. The 12 effect of this initial application was to equalize the rate for 13 residential service between the state of South Carolina and 14 North Carolina. The Application was assigned Docket No. 18,361,

'I 15 and the proposed rates went into effect under bond, subject to 16 refund, on September 1, 1975, in .accordance with the 17 Commission's Order No. 18,532.

18 On August ll, 1975, the Company filed an additional Appli-19 cation requesting a general increase in its rates and charges 20 for retail service in South Carolina. This Application was 21 assigned Docket No. 18,387. Subsequent to the filing of the 22 general application, the Commission consolidated the two dockets 23 into one proceeding. Exhibit B filed with the Application on

August 11, 1975, contains the rates and rate schedules proposed by the Company. For convenience, the proposed schedules are presented with this testimony as Davis Exhibit No.'.

It should be noted that these schedules contained a "roll-in" of 5.54 mills per KWH to reflect an increase in the cost of fuel reflected in the base rate charges. At the time of the filing, it appeared that this level of cost was a reasonable expectation for,the current cost of fuel. However, the Company's experience has been more favorable, and the cost of fuel has 10 stabilized at a level below the requested roll-in figure. .As a result of this improvement in the cost of fuel, an adjustment was made at the time the requested rates became effective under bond 13 for service rendered on and after March 1, 1976. Rider No. 35A, 14 which has been included as a part of Exhibit B, was placed into 15 effect to reduce the requested rates by $ 0.005536 per KWH t'o 16 remove the roll-in requested by the Company and allow the 17 presently approved fuel clause to continue in effect.

18 Q. Does the Company propose that the filed rates continue in effect on 19 a permanent basis including Rider No. 35A to adjust for the 20 difference in fuel cost?

21 A. No, we do not. We have simply made an adjustment to allow the I

filed rates to go into effect on an interim basis, pending a 23 decision of the Commission as to how the rates should reflect a 24 reasonable current cost of fuel. If the present Fossil Fuel

Adjustment Clause Rider No. 32B were to remain in effect, it would be desirable to adjust the kilowatt-hour charges in each I

rate rather than to continue the adjustment through Rider No. 35A. It would also be possible to raise the base cost reflected in the fuel clause and adjust the charges in the basic rates. This would reflect a lower roll-in than originally requested by the Company but would raise'he base of the fuel clause above its present level.

In addition to the originally proposed rates and adjust-

'0 ment to the fuel charge roll-in, I will present an alternative method for the recovery of fuel costs in excess of, those 12 reflected in the base rates. This alternative method would 13 include a fuel adjustment clause based on changes in the cost 14 of fuel, including nuclear fuel. Later in my testimony, I will 15 present the specifics of the development of this fuel adjustment 16 clause and will present proposed base rate schedules that would 17 be necessary to implement this alternative method of recovering 18 total fuel cost.

19 Q. Is the Company proposing or requesting any additional change 20 related to the application of the fossil fuel charge7 21 A. Yes, we are. We would request that the fuel charge approved by 22 the Commission in the proceeding be applied to the non-metered sales, including the lighting classifications. At the present 24 time, the fuel charge only applies to metered sales. We have

developed an administrative procedure by which the charge can be applied to non-metered sales on the basis of the estimated kilowatt-hour usage which 'is used in establish-ing and reporting sales under the basic rate. Me are requesting Commission approval to apply the fuel charge on 6 the basis of this procedure which would be consistent with 7 the present practice of the other major utilities in this 8 jurisdiction.

9 Q. Do the rate schedules that you are presenting provide for a 10 uniform increase among the customer classes.

11 A. No, they do not. The rate increases proposed in this 12 proceeding are not on an across-the-board basis, but vary

/

13 with regard to recent financial results from the various 14 customer classes. The re'lative increases to the classes 15 seek to recognize the areas of cost differences in providing 16 'ervice and are based in part on the results of our most 17

"

recent retail operations cost allocation study.

18 At the time of the preparation of the rates filed in this 19 proceeding, the results of the 1974 cost of service study were

.20 available. These results which indicated the relative rates of 21 return between the retail rate classifichtions were used as one 22 of the guides in determining the percentage increase for each 23 customer class.

On the basis of 1975 sales the average percent increase on the retail classification on total charges, including fuel revenues, is approximately 27%. On the basis of an average 27% rate increase, there are variations within the various customer classes. The residential class will receive a total increase of about 32.5%. This increase is a combined total of the two requests in this proceeding. The higher-than-average increase also reflects the fact that the residential class rate of return is below the retail average. The small general 10 service class will receive an average increase of 20.5%. The lower-than-average increase is in recognition of the fact that 12 the rate of return for this classification is above the retail 13 average. The large general service rates would receive an 14 increase of 26%, which is slightly less than the average retail 15 increase. The schedules for service to the lighting class of 16 customer will receive an average increase of 16.45%. This is 17 the lowest increase that can be applied to the customer class 18 consistent with the receiving of fair rate of return from the 19 classification.

20 As a result of the Company's rate history and of its prior 21 marketing policy, which produced very successfully a balanced 22 system load with a high growth at a time when those aspects were 23 beneficial to our customers, the Company has a relatively large 24 number of existing rate schedules for retail service. A primary

objective in our prior rate proceeding was the reduction of the number of our retail schedules. We proposed and received Commission approval to eliminate a net of six rate schedules in our prior case.

We would propose to continue this improvement in our rate structure by the elimination of four additional active rate schedules. We are proposing to administratively freeze the availability of three rate schedules, RF-1, AH-1, and SC-1. To avoid severe financial impacts on the present customers 10 served under these three rate schedules, we are not requesting the immediate transfer of the present customers to other rate 12 schedules. We are proposing instead to limit the availability of 13 the schedules to the existing customers and to place a higher-than-14 average increase on these rates in order to move the charges into 15 closer alignment with our General Service Rates. It is anticipated that over a period of time, the customers, because of changing load 17 characteristics and differences in the existing rates, will move to 18 the general service rates, and it will be possible in future rate 19 filings to complete the process of eliminating these three 20 schedules.

21 We are requesting the elimination of the House Construction 22 Rate Schedule, HC-1. This rate provides temporary service during 23 the construction of residential housing units. We would propose 24 to replace Rate Schedule HC-1 with our standard Small General 25 Service Rate, G-l, and serve the builder on the general service

rate until the permanent service is installed for the residential unit. At the time the permanent service is installed to the residence, the residence would then be billed on the standard 4 residential rate for which the residence qualifies. This will 5 eliminate the need for a separate rate schedule for service dur-6 ing the time the house is under construction. This change will 7 improve our rate administration and I

limit the availability for temporary service to our standard small general service rate.

This proposedprocedure will have a significant financial impact 10 on the existing HC-1 customers. The rates presented in Davis Exhibit No. 2 containing the modifications described above and 12 others set out therein constitute a set of just and reasonable 13 rates appropriate for our Company and the various -types of 14 customers in our service area.

15 Q. Will you please describe the manner in which the proposed rates 16 recover the fuel expense of the Company?

17 A. The rates proposed in this proceeding were designed based on a 18 total fuel cost component of 1.010 cents per kilowatt-hour. The 19 rates were designed during 1975 and reflected average fuel costs 20 experienced during 1974. The 1975 test year fuel expense when 21 annualized for the operation of the Brunswick No. 2 nuclear 22 generating unit is below the fuel cost level designed into the 23 rates originally filed in this proceeding. A lower cost of fuel 24 would be more appropriate in setting rates at this

'time.'13-

A fuel cost level of '8.60 mills per kilowatt-hour sales is a more appropriate level to reflect current costs in the design of the rates.

Davis Exhibit No. 3 is a fuel adjustment clause which we would propose for the consideration of the Commission. As indicated in the exhibit, we have established 8.50 mills per kilowatt-hour as the base cost for the fuel adjustment clause to include both nuclear and fossil fuels and the effect of purchase and interchange power. Me would recommend this 10 clause to the, Commission to replace the present adjustment clause which recognizes changes only in fossil fuel costs.

12 Since the base cost of fuel reflected in this fuel adjustment 13 clause is below the level of 1.01 cents per kilowatt-hour 14 included in the original filed rates, it. is necessary to adjust 15 the base rates to which the clause would be applicable. Davis 16 Exhibit No. 4 is a set of alternative rates which have been 17 adjusted to reflect the base cost included in the proposed 18 alternate fuel adjustment clause. These rates are identical 19 to the rates approved for service in our North Carolina territory.

20 Approval of this set of rates and the accompanying fuel clause 21 would return the Company to uniform rates,'throughout its retail

'22 service area.

23 Q. Did you use the results of the 1974 retail cost allocation study 24 in the design of the rates requested in this proceeding?

1 A. Yes, I did. The relative relationship of the rates of return among the various customer classes, and,'..to a lesser extent, the individual rate schedules, was used as a guide in the distribution of the rate increase among the customer classes.

As we have testified in earlier rate proceedings, we are committed toward moving our rate structure and designing our rates in such a manner as to produce a more uniform rate of return among the retail classes. We made considerable pro-gress in our last rate case in applying the increase such 10 that the rates of return would move toward the overall retail average. We have attempted to contine that movement in this rate case.

13 It should be recognized, however, that there are 14 restraints against moving directly to a uniform rate of return 15 among the various customer classes. These restraints include 16 the relationship between the individual rate schedules, the 17 overall revenue requirement and the revenue effect on individual 18 customers. It is necessary and desirable to make the transition 19 and changes in the rate schedules on a gradual and smooth basis, 20 rather than introduce abrupt changes. We tried to design our 21 rates within all of those restraints and make as much progress 22 toward a uniform rate of return as these conditions would allow.

23 Even without the restraints that exist in abrupt rate 24 changes, it would not be desirable to structure our rates to 25 produce a uniform rate of return on the basis of one test period.

This is true because the equal rates of return would be'measured by a historical test period and would not exist when the rates became effective. It would not be possible to measure the result-ing variation in rates of return until the rates had been in effect and a cost study performed at a later date. It is there-fore desirable to set the rates of return within a reasonable range rather than seeking absolute uniformity on the basis of a 8 past test period. In the application of the requested rate 9 increase, we have improved the variation from the average retail 10 'ate of return for each of the customer classes.

ll Q. Please describe the manner in which the rates requested in this 12 proceeding were designed.

13 A. The first step in the design of the requested rates was to 14 distribute the required additional revenue among the retail 15 classes on the basis of the results of the retail class alloca-16 tion study and in proportion to each class based on its percentage 17 of the Company's revenues. It was proposed in the case of the 18 residential class to apply an increase necessary to bring the 19 residential class rate of return to a point closer to the retail 20 average return. It was likewise concluded to apply less than the 21 average increase to the Small General Service class in order to 22 continue the movement of the rate of return from that class down-23 ward toward the retail average. It was proposed to apply 'the 24 minimum increase to the lighting classification necessary to bring 25 the rate of return slightly below the retail average. Slightly 16-

less than the overall average increase was applied to the Large General Service classification. The results of these computations were to determine a revenue requirement for each of the retail classes. The rates were then designed within those classes to produce the total revenue requirement, and to maintain the proper alignment and relationship between the rates.

In the case of general service rates, the most signifi-cant design feature change'as to incorporate in both small and 10 large rates which include a separate demand charge a 12-month seasonal ratchet to establish the minimum billing demand. This 12 design change was made to increase the amount charged for demand 13 in order to create more incentive to conserve electricity.

14 The new billing demand feature establishes the minimum 15 billing demand based on 90% of the customer's maximum demand in 16 the prior summer peak months of July through October. This form 17 of pricing encourages customers to reduce their demands during 18 the summer peak period. In addition, a billing provision has 19 been established as a minimum of 50% of the demands during the 20 off-peak winter season months; and as an administrative iequire-21 ,ment, .a minimum of 75% of the contract demand until such time as 22 the actual demand equals the contract demand. This total ratchet 23 provision enables the customer to control his billing demand by 24 reducing his consumption during peak periods. It establishes a

12-month ratchet rather than the previous provision in our schedules. The definition of contract demand has been'evised in the proposed rate schedules and service regu-4 lations to conform to the new ratchet provision.

5 Q. Have you shown the results of applying the proposed rates to 6 the individual customer classes?

7 A. Yes, I have. Davis Exhibit No. 5 presents a summary of the 8 results of the cost allocation study indicating the rates, of 9 return for the retail classes that would have been realized 10 during the 1974 test year if the requested rates had been in effect during the entire period. It should be noted that 12 these rates of return are valid only for comparison of relation-13 ship between the rates and do not indicate the correct rate of 14 return for )urisdictional ratemaking. A comparison of this 15 exhibit with Horne Exhibit No. 2 would indicate that the 16 proposed rates improve the variation from the retail average 17 from each of our rate classifications.

18 Q. Have you shown the results of the proposed rates'n a 1975 test 19 year basis?

20 A. Not on a retail class basis. The 1975 retail cost of service 21 study had not been completed and the results were not available't 22 the time of the preparation of this testimony. The initial 23 rate design was based on a 1974 test period, and the results I 24 have shown for the retail classes are based on the 1974 cost of 25 service study.

18-

1 Q. Will you now please describe the monetary effect that the proposed rates would have had on the Company's jurisdictional 3 operation as adjusted had the proposed rate changes been in effect throughout the 1975 test period?

5 A. These materials are shown on Davis Exhibit No. 6. Column 2

\

6 of Page 1 of this exhibit is identical through Line 25 with 7 Column 7 of Davis Exhibit No. 1. For convenience, it restates 8 the actual operating results with appropriate adjustments apportioned to the South Carolina retail operations. Column 3 10 sets forth the effect of the proposed rates had they been in force throughout the test period. As shown thereon, the addi-12 tional revenues would have been about $ 22,486,985. Additional 13'4 gross receipts, state and federal income taxes arising as a result of these additional revenues, would have amounted to 15 $ 11,528,321 or 51.27% of the gross revenue increase. The addi-16 tional net operating income for return would have been 17 $ 10,958,664. Thus, with the increase applicable to South 18 Carolina retail sales, the net income for return, including 19 customer growth, would have been $ 31,055,486, as shown on 20 Line 18 under Column 4.

21 Q. What else is shown on Page 1 of Davis Exhibit No. 82 22 A. Lines 19 through 30 show the original cost net investment consisting of net electric plant in service, plus an allowance 24 for working capital. The total original cost net investment is

shown on Line 30. As stated there, the apparent return in the test year at the present rates would have been 5.98%; and had t

the proposed rates been in effect for the entire test period, this indicated rate of return would have been 9.27%.

5 Q. What rates of return would have been indicated in the test year common equity?

7 A. As indicated on Page.3 of Davis Exhibit No. 6;,the requested rates would have produced 12.18% on actual common equity in the test period. This corresponds to an allowance in our prior rate 10 order of 12.50%.

ll Q. Is it your testimony in this proceeding that Carolina Power &

12 Light Company will realize from the requested rates a return 13 of 9.27% original cost rate base and 12.18% on total book equity?

14 A. No, it is not. Mr. Harris and other witnesses have testified in 15 this proceeding to the fact that economic conditions will operate 16 to prevent the Company from earning the rate of return allowed 17 by this Commiss'ion on a historical test year basis.

18 Even though the test year rate of return computations indi-19 cate a return on equity of 12.18%, the Company will not have an 20 opportunity to earn that rate of return. The rates did not go 21 into effect in the full amount of the increase until March 1, 22 1976.

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